WHAT IS DERIVATE MARKET?
Futures Contracts: These are standardized contracts to buy or sell an underlying asset at a predetermined price on a future date. Common underlying assets include commodities like oil or gold, stock indices like the S&P 500, or interest rates.
Options Contracts: Options give the holder the right (but not the obligation) to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) within a specific period. Options are used for hedging and speculative trading.
Swaps: Swaps are agreements between two parties to exchange cash flows based on different financial instruments. Common swaps include interest rate swaps and currency swaps, which are used to manage interest rate and foreign exchange rate risks.
Forwards: Similar to futures contracts, forwards are agreements to buy or sell an asset at a predetermined price on a future date. However, forwards are typically customized contracts traded over-the-counter (OTC), making them less standardized than futures.
Derivative markets serve several important functions in the global financial system:
Risk Management: Derivatives allow businesses and investors to hedge against price fluctuations, interest rate changes, and other financial risks. For example, a farmer can use futures contracts to lock in the price of their crop before harvest to protect against price volatility.
Speculation: Traders and investors use derivatives to speculate on the future movements of asset prices, hoping to profit from price changes without owning the underlying assets.
Price Discovery: Derivative markets often provide valuable information about the future expectations of asset prices. Prices of derivatives are influenced by supply and demand dynamics and can reflect market sentiment and economic conditions.
Leverage: Derivatives often allow traders to control a large position with a relatively small amount of capital, which can magnify potential gains but also increase the level of risk.
