Financial Times Guide to How the Stock Market Really Works, 5th Edition

7

Derivatives

Derivatives are financial instruments that are ‘derived’ from assets such as equities, bonds and commodities. They evolved from the commercial needs of the producers of basic goods to try to reduce their risks, which are essentially unpredictable fluctuations in supply (for example, bad harvests) and demand (for example, a market drying up because of new technology). Derivatives are used to ‘hedge’ against these risks, and can be seen as a type of insurance. However, they can also be used for speculation, and, as we will see in this chapter, many large organizations have incurred stupendous losses in operations that were supposed to hedge against risk, but in fact increased the risk exposure. The derivatives field has greatly ...