How To Guide For: Understanding The Basics Of Financial Derivatives

Derivatives are financial contracts that derive their value from an underlying asset. The underlying asset can be stocks, bonds, market indexes, commodities, currencies and interest rates. These financial instruments help you make profits by betting on the future value of the underlying asset. So, their value is derived from that of the underlying asset. With derivatives, you are buying a promise from the original owner of the asset to transfer ownership of the asset rather than the asset itself. This promise gives you immense flexibility and is one of the most important trait that appeals to investors. Derivatives are used to hedge risks and for speculative trades. The purpose of derivatives is to allow traders to maximize returns and simultaneously limit their risk exposure. Not everyone is a fan of Derivatives. Warren Buffett described derivatives in a 2002 letter to Berkshire Hathaway Shareholders (page 15) as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” But according to The New York Times in a 2011 article, Buffett now says the real problem with derivatives is "when a bank’s exposure to derivatives balloons to grand proportions and uninformed investors start using them". Derivatives are not for every investor. It's just useful to know what they are and how they work just in case you decide you want to try it out. There is so much more to learn about derivatives. To get more in depth information on financial derivatives click on the pictures below to read the articles.

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