Derivatives enable traders to bet on price movements without having to deal with actual assets Mention derivatives and most people think of Nick Leeson, highly risky financial investments and City 'wide boys' making lots of money. But, insurance, farmers and complex mathematical formulas are as central to the concept of derivatives as the rowdy dealing pits depicted in the Eddie Murphy film Trading Places.
Derivatives are simply financial instruments which derive their value from some underlying asset.
The three basic types are futures, options and swaps. Nick Leeson failed to sell the contracts at the right time New ones are even being developed on catastrophes, such as earthquakes, and even on the creditworthiness of investors. They are used as both a type of insurance and as a way of making money. They are much more flexible than the underlying products because they are simply a monetary value. The value is based on the price of the underlying product, but most contracts are settled in cash terms.