Modern Economic Derivatives

Modern economies often utilize a set of complex system of measurements. This is certainly true when it comes to the stock market and international trading. One of the most well known measurements in trading today is the modern day concept of the “derivative”.

A derivative can be defined as a market security that has a price which is dependent upon, or derived, from one or multiple underlying assets. Determined by the value of fluctuation in the underlying asset, the most common assets a derivative derives its value from include stocks, bonds, interest rates, market indexes, commodities, and even currencies.

These derivatives are extremely common on the modern day market itself, and can either be exchanged in an official manner, or even traded by an “over-the-counter” means. As can be expected, those derivatives which are exchanged in an official manner in the market are subject to standardization, whereas OTC (or, “over-the-counter”) exchanges are unregulated.

Derivatives were originally concepts used to balance the exchange rates of goods and services which were internationally traded. Before the introduction of this handy tool, every market and individual economy (that is, an economy of every single specific country in the world) had its own differing national currency values. This wide discrepancy could often time cause market chaos, and so the idea of a derivative was born. Because derivatives are a form of security, they are often times measurements of form towards insuring against any risks that might befall upon an asset. In a way, a derivative is like the common day version of insurance. Like insurance policies as well, derivatives can also be applied to a wide variety of assets and their individual markets.

But risks can also be taken when investing in derivatives, and a popular form of this is by using derivatives for speculation purposes. Although there may be a high risk involved, the profits accrued from speculative derivatives can be enormous, especially for those who are well experienced when it comes to stock market trading. The most common form of a derivative is the “future contract”. These contracts are exactly what the name implies; an agreement between two parties in which an asset is sold at an agreed upon price. Many traders use this option when hedging against a trading risk during a specific period of time.

Another two lesser known types of derivatives include “forward contracts” and “swaps”. The former is quite similar in language to a “future contract”, but the key difference lies in it only being tradable through OTC means. “Swaps”, on the other hand, can be traded either officially or not, but these are derivatives based on an agreed trade loan term. For many traders, this is the perfect option available when attempting to switch from a variable interest rate loan to a fixed interest rate loan.

In whichever manner a trader decides to utilize the services a derivative can provide, it is undoubtedly one of the most remarkable aspects of the modern international market, as it provides increased security against a world of ever growing risks.

Further Reading