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A derivative is a financial instrument, essentially a contract, whose value is derived from the value of another asset or variable. This underlying asset or variable can be anything from a stock or bond to a commodity price, an interest rate, or even a market ...

Derivatives likely originated in simpler forms, possibly as agreements between merchants or farmers to lock in future prices for goods. These would have been primarily bilateral agreements (similar to today's OTC forwards). Growth of Organized Exchanges (19th-...

Participants: Hedgers: These individuals or entities use derivatives to reduce their exposure to existing risks. For instance, a farmer might sell futures contracts on their crops to protect against price declines, or a company expecting a foreign currency p...

Exchange-Traded Derivatives: Centralized Trading: These derivatives are traded on organized exchanges, providing a central marketplace. Standardized Contracts: Contract terms (size, settlement date, etc.) are standardized, ensuring uniformity and liquidity....

1. Forward Contracts Definition: A forward contract is a private and customizable agreement between two parties to buy or sell an underlying asset at a predetermined price (the forward price) on a specific future date (the settlement date). These contracts are...

Derivatives can be classified based on the type of underlying asset: Equity Derivatives: Underlying assets are stocks or stock indices (e.g., S&P 500 futures, options on individual stocks). Fixed Income (Interest Rate) Derivatives: Underlying assets are bon...

Derivatives are always speculative and risky: While derivatives can be used for speculation, they are also essential tools for risk management and hedging. Companies use them to mitigate various risks, such as interest rate, currency, or commodity price fluc...

Both forward and futures contracts are agreements to buy or sell an underlying asset at a predetermined price on a specified future date. They are fundamental tools in financial markets, allowing participants to manage price risk or speculate on future price m...

Forward Contracts: Customization: The key feature is flexibility. Parties can negotiate all terms, including the underlying asset, quantity, price, and settlement date. Over-the-Counter (OTC) Trading: Forwards are traded directly between parties, not on an...

While the underlying assets can vary widely, here are some common categories: Forward Contracts: Currency Forwards: Used to hedge against exchange rate fluctuations. Example: A U.S. company expecting a payment in Euros in six months can enter into a forwar...

Forward Contract Trading: Negotiation: Two parties (e.g., a buyer and a seller) directly negotiate the terms of the contract. This can be done through a dealer or broker, or directly between the parties. Agreement: Once terms are agreed upon, the contract i...

Feature Forward Contract Futures Contract Trading Over-the-counter (OTC) Exchange-traded Standardization Customized Standardized Contract Size Negotiable Fixed by the exchange Delivery Date Negotiable Standardized (specific delivery months) Regu...

The futures price is the price at which a futures contract trades on an exchange. It represents the market's expectation of the spot price of the underlying asset at the contract's settlement date. However, the futures price is not simply a prediction of the f...

The payoff of a futures contract at expiration is the difference between the futures price at which the contract was initiated and the spot price of the underlying asset at expiration. For a Long Position (Buyer): Payoff = Spot Price at Expiration - Futures ...

Margin accounts are a crucial aspect of futures trading. They serve as a performance bond, ensuring that traders can meet their obligations. Key Concepts: Initial Margin: The amount of money a trader must deposit with their broker when initiating a futures p...

Lot Size Lot size refers to the standardized quantity of the underlying asset specified in a futures contract. It represents the minimum amount of the asset that can be traded under a single contract. Examples: Crude Oil: 1 lot = 1,000 barrels Gold: 1 lot =...

Volume: Definition: The number of futures contracts traded during a specific period (usually a day). Indicates: Market activity and liquidity. Higher volume generally suggests greater liquidity, making it easier to enter and exit positions. Example: If 50...

Hedging is a risk management strategy that involves taking an offsetting position in a related asset to reduce the risk of adverse price movements in the primary asset. Futures contracts are commonly used for hedging. Types of Hedges: Short Hedge (Selling Fu...

Arbitrage is the simultaneous purchase and sale of an asset in different markets to profit from price discrepancies. Futures contracts can be used in arbitrage strategies. Cash-and-Carry Arbitrage: This strategy exploits mispricing between the futures market a...

An option is a financial derivative contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (the strike price) on or before a specific date (the expiration date). Think of it like this: An op...