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The Deal on Financial Derivatives

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Financial derivatives are instruments of investments that take the value of something else. Hence, financial derivatives have no intrinsic value. In high finance, financial derivatives are taken in form of contracts where a party pays for an asset and arranges for a payment at a particular point in time. The main types of derivatives are futures, forwards, options, and swaps (Wikipedia 2007 [online]).

 

A transaction on derivative financial pricing can be illustrated in simple terms. As an example, a certain John sells a contract to Jane according to the value of oil. In a futures contract, John is obligated to buy back the contract from Jane after two weeks. By that time the value of oil may have dropped or increased. If the value of oil dropped then John loses his investments. However, if the price of oil increases, then John made money off his investments. In simplistic terms, a financial derivative investment is a wager on the value of another product.

 

Financial derivatives are made on a wide arrange of products including foreign currencies, metals, bushels of wheat, stock, and government bonds. The derivative market has become an experimental environment for leisure stock trading found today in the internet. These special internet sites can speculate on the value of a celebrities or athletes.

 

Financial derivatives follow the economic exercise of speculation or prediction. John Maynard Keynes (1936) likened speculation and derivative thinking to be “anticipating what the average opinion expects the average opinion to be.” The value of speculation in a short term markets on financial derivatives is an established exercise since Keynes.

 

Despite being one of the most complex, if not the most sophisticated financial tool today, financial derivatives have a long economic history that gave an idea of economics though during these times. Futures trading started in 12th century Europe when traded sign contracts that promise to future delivery of items were sold. In this sense the sale was made even before the delivery. By the time of the delivery, the price of that good might have changed. However, since the contract stands, traders in financial derivatives are forced to speculate on the value of the good being produced. Trading of futures is essential in those times to give a safeguard for sellers during bad weather or warfare (Gambling on Derivatives nd)

 

Financial derivative markets also appear to have more volatility than stock exchanges. Since the value is derived, a lot of people speculate on the value of these sticks which causes either a tremendous upswing or downswing that either provides a high risk and high interest.

 

The science of financial derivatives is never exact and far from being organized. What financial derivatives expect from investors is the ability to forecast. A wise guess and sound information is the key to any success financial derivatives. However, it is important for a beginning investor to know the basics first before employing such markets. Winners of this game of financial derivatives end up taking handsome return for their investments while putting unwanted buyers in danger of such risks.

 

 

References

 

Wikipedia. (2007). Financial Derivatives. Available: http://en.wikipedia.org/wiki/Financial Derivatives. Last accessed 18 October 2007.

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