Derivatives: Financial investment instruments: The first stock market of the world the New York Stock Exchange was established in the 17th century. The first stock market in India was established in the 19th century. It has been around more than 150 years of the establishment of the stock market despite a mere 3.4% of the total population of India invests in the stock market. The reason for such a scarce number of people investing in the stock market is the risk-aversive nature of the people.
But with the independence of the country and economic liberalization, a paradigm shift has been observed. The people from the middle class started entering the stock market with mid-range capital. Initially, the investments which were made were seen to be of low to negligible risk and with guaranteed returns no matter how small the margin. With time people became more risk takers so that they can generate significant profit.
In quest of these things’, derivatives came into the picture. A derivative can be defined as a financial instrument whose value is determined by an individual or a group of assets. There are several derivatives types present in the market such as swaps, options, futures, etc. There is no denial that derivatives are a lot riskier than regular stock trading, but it is the vast profit margin that tempts the players to continue playing in the derivatives market.
Advantages of derivatives:
Hedging: Derivatives are predominantly used as a hedging tool by investors to make up for their future losses. Suppose an investor buys a derivate contract whose underlaying asset the investor already owns. Suppose with the flow of time the value of that asset goes on decreasing, then the investor’s physical possession of the asset presents him with loss, but the possession of the derivative makes up for that loss.
Determining prices: Derivatives prove to be particularly useful in the determination of the price of the underlying assets. This is one quality that enables the investors to know about the future condition of the market and the investor can then make trades accordingly. The prediction may or may not be accurate to book profits but is capable enough to ditch losses.
Efficiency measure: Derivatives also act as a measure of the efficiency of the stock market. In other words an indicator of the flourishing of a market. Well, they obviously cannot be compared to the market indices. But better enough to give a fair idea of the market to the traders for the day or the past period.
Economically advantageous: Derivatives are also economically advantageous for organizations since derivatives allow the swap of interest rates and so the borrowers might get an interest rate much lower than the usual one thus shortening the prevalent interest amount to be paid. It also allows the organization access to unavailable assets and markets.
The facts and details mentioned above not only praise the existence of derivatives but provides a critical view of the picture. The very profits, losses, and risks associated with the investment have been explained clear cut.
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