Hi guys. I have to learn about financial derivatives, but I don't exactly understand what are they. I was reading some topic about it on Google, but it isn't clear. What I get for my money if I am investing to financial derivatives. It is a kind of insurance? According to investopedia derivative is: A security whose price is dependent upon or derived from one or more underlying assets. So it is basically a contract?

Thanks!

Yes, they are a "kinda" insurance. Lets say you are an airline. What are your fuel costs? What if they vary greatly. A derivative contract would give you a fixed point above which the contract would kick in. Lets say you have determined the fuel price for the years is $X. However, Iran says they now have an A bomb and will use it on Saudi Arabia. What do you think would happen to the cost of fuel. So, you enter a contract to set the max price you will pay, at which point the derivative would take over. In GA, where I live, we have open market Natural Gas costs. Anyone can buy their NG from anyone. Each year, I am solicited to buy NG. This last year renewal varied from 54 to 69 cents per therm. I contracted at 54 but the winter has been bad and NG prices are way up. I'm protected but I would bet there are derivatives in place so the utilities are protected in price increase from the suppliers. Derivatives are not typically something an average person would use. Large purchasers with potentially variable costs are the typical market.

See it as a package (bundle) with a certain value based on the component of the package. If all but one component is low risk, and one is higher risks then the value of the total is marked down to reflect that added risk of the components of the total package. Financial derivatives are rated by an agency (FEC), but other entities rate all kinds of other types of derivatives.


There is always a risk of prices dropping and suffering loses, just as the price going up, and gaining profit. So the real insurance value is in the assignment of risk assessment being realistic, and credible.

Thanks guys now its clearer!