For traders there is a large toolkit for financial transactions to profit on the difference in exchange rates when trading valuable assets. These popular and convenient tools are called derivatives.
Derivative - a type of agreement (transaction) based on the potential value of a particular valuable asset.
The principle of derivatives, the pros and cons
The owner of the derivative has an agreement that he will purchase a certain (basic) product. This product does not even have to be stored somewhere and the mere fact of having a derivative already gives you the right to use the product that you are obliged to sell / buy / rent / exchange. In turn, the owner of the derivative also agrees to fulfill its conditions and purchase goods. All necessary conditions for the transaction are negotiated at the conclusion of the contract.
Derivatives can be used for speculation in order to make money. You can easily sell it to someone for real cash or securities. Also, they are often used for hedging. For example, if the underlying product is any stock that has risen sharply in price, the derivative makes it possible to purchase them at a previously agreed lower price. Often, hedging is much more important than directly receiving the goods. Of course, as elsewhere in the market, a derivative can not only make a profit, but also a loss.
Derivative transactions are distinguished by several features:
• The presence of an underlying asset to purchase.
• A purchase or sale transaction occurs at a predetermined time.
• There are investments in the form of a guaranteed deposit.
Like any transaction in the financial market, the derivative has its pros and cons.
Pros:
• Guaranteed receipt of the underlying asset at the scheduled time.
• Simpler tax accounting.
• The risks that the transaction will not be completed are almost zero.
Cons:
• Unpredictable price volatility, which depends on a huge set of factors.
• Different countries have their own derivatives policies; there are no uniform rules.
• In transactions involving different countries, exchange rate fluctuations greatly exacerbate risks.
Types of derivatives
There are several most common types of derivatives that are usually divided into two groups: by type of transaction and by type of asset.
By type of transaction:
• Futures (futures contracts). An agreement to buy or sell an underlying asset at an agreed price, at a strictly defined point. The price and date of the transaction are negotiated at the time of conclusion of the standard contract. Futures are used on exchanges where they are extremely popular.
• Forwards. Similar to futures, but used outside of exchanges. The price here is agreed in advance and does not change after the transaction. It differs from the futures in that the forward cannot be terminated. The conditions for concluding a non-standard contract are negotiated only between the seller and the buyer.
• Options. The type of agreement in which the buyer can make a transaction (purchase or sale) of the asset to another person, but only after the seller has paid the option a special fee from the new buyer, in other words, a pledge. Both parties cannot avoid fulfilling the terms of the contract, but if the owner of the contract wants to sell the asset, but the transaction does not occur within the limited duration of the option, the amount remains with the seller. Extremely popular type of transactions in stock markets.
• Swap. The ability to make a double purchase and sale transaction, postponed in time, where each of the transactions will have its own conditions. A popular tool among speculators.
By type of asset:
• Currency.
• Securities - stocks, bills, bonds, etc.
• Precious metals.
• Goods - raw materials, food and non-food products.
