5 Questions
Name five types of underlying assets on which derivatives are based.
Metals such as Gold, Silver, Aluminium, Copper, Zinc, Nickel, Tin, Lead; Energy resources such as Oil (crude oil, products, cracks), Coal, Electricity, Natural Gas; Agri commodities such as wheat, Sugar, Coffee, Cotton, Pulses; Financial assets such as Shares, Bonds and Foreign Exchange.
What are some factors driving the growth of financial derivatives?
Increased fluctuations in underlying asset prices in financial markets; Integration of financial markets globally; Use of latest technology in communications has helped in reduction of transaction costs; Enhanced understanding of market participants on sophisticated risk management tools to manage risk; Frequent innovations in derivatives market and newer applications of products.
What is a derivative?
A contract or a product whose value is derived from value of some other asset known as underlying.
What is the role of derivatives in risk management?
Derivatives provide sophisticated risk management tools to market participants.
What are some examples of financial derivatives?
Shares, Bonds and Foreign Exchange.
Study Notes
Underlying Assets of Derivatives
- Five types of underlying assets on which derivatives are based: currencies, commodities, bonds, stocks, and indices
- These underlying assets determine the value of the derivative contract
Growth of Financial Derivatives
- Factors driving the growth of financial derivatives: increased globalization, advancements in technology, and rising demand for risk management tools
- Globalization increases trade and investment, leading to a greater need for derivatives to manage risks
- Technological advancements make it easier to trade and price derivatives
- Growing demand for risk management tools drives the development of new derivatives
What is a Derivative?
- A derivative is a financial contract that derives its value from an underlying asset, commodity, or security
- The value of a derivative is determined by the price of the underlying asset
- Derivatives allow investors to benefit from price movements without actually owning the underlying asset
Role of Derivatives in Risk Management
- Derivatives play a crucial role in risk management by allowing companies to hedge against potential losses
- Companies can use derivatives to manage risks associated with fluctuations in interest rates, exchange rates, or commodity prices
- Derivatives help to reduce uncertainty and increase predictability of cash flows
Examples of Financial Derivatives
- Options: give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price
- Futures: obligate the buyer and seller to buy or sell an underlying asset at a predetermined price on a specific date
- Swaps: involve exchanging cash flows based on different underlying assets, such as interest rates or currencies
- Forwards: customized contracts that enable companies to hedge specific risks
Test your knowledge on derivatives with this quiz! Learn about the different types of derivatives and the underlying assets they are based on, including metals, energy resources, and agricultural commodities. Challenge yourself and see how much you know about this important financial instrument.
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