What are the Features of Derivatives Market?
- 02 Apr 2024
- By: BlinkX Research Team
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Derivatives are contracts whose value is determined by the performance of an underlying asset, index, or other financial variable. They are an essential instrument in financial markets for risk management, price speculation, and portfolio management. Derivative markets are critical in modern economies because they provide various financial tools for risk management and capital allocation. For example, airlines may use futures to lock in future fuel rates, eliminating the uncertainty caused by fluctuating oil prices. These markets have become increasingly active during the last several decades, adding to the stability and efficiency of financial institutions.
Understanding Derivatives Markets
Most derivatives are traded over-the-counter (OTC) between two counterparties, such as banks, asset managers, corporations and governments. These professional traders have signed documents in place with one another to ensure that everyone agrees on standard terms and conditions.
However, some contracts, including options and futures, are traded on stock exchanges. Derivatives, such as equities, fixed income, commodities, and foreign exchange, can also be bought and sold on the share market.
Here are the two types of derivatives:
- Over the counter (OTC) - The most significant derivatives landscape is OTC, where they are exchanged without an exchange. Privately traded goods such as forward rate agreements, swaps, and exotic options are traded between hedge funds, banks, and other financial firms.
- Exchange-traded derivative contracts (ETD) - As the name implies, these instruments are exchanged on a derivatives exchange, which functions as a middleman for all connected transactions. As a guarantee, buyers and sellers deposit an initial margin of the contract.
Table of Content
- Understanding Derivatives Markets
- Features of the Derivative Market
- Types of Derivatives
- Advantages and Disadvantages of Derivatives
Features of the Derivative Market
Here are 5 major features of derivatives markets. These include:
Types of Derivatives
Mentioned here are the types of derivatives in the market:
Swaps are private agreements between parties that are transacted over the counter rather than on stock exchanges. The two most common forms of swaps are currency swaps and interest rate swaps. For example, an interest rate swap can be used to convert a variable-interest loan to a fixed-interest loan or vice versa.
Advantages and Disadvantages of Derivatives
Here are the advantages and disadvantages of derivatives:
Advantages of Derivatives | Disadvantages of Derivatives |
Lower Transaction Costs: Trading derivatives typically incur lower transaction expenses compared to stocks or bonds. The nature of derivatives, designed primarily for risk control, contributes to reduced costs. | Loss of Adaptability: Standardised contracts in exchange-traded derivatives limit flexibility. The inability to tailor these contracts reduces adaptability, as terms and conditions are pre-specified without room for negotiation. |
Hedging Risks: Derivatives serve as an effective tool for hedging investment risks. They allow investors to create positions that offset existing risks, serving as insurance policies to mitigate market volatility. | — |
Conclusion
Derivatives, pivotal in risk management and maximising financial opportunities, necessitates a comprehensive grasp. Leveraging a dependable share market app becomes indispensable, providing indispensable insights and analysis for making informed, strategic decisions in dynamic derivative markets. Therefore, you can explore the features of the derivative market.