Derivatives serve an important function in the market. They are a very good tool to hedge your risk. Remember that you may lose chance to make extra money if things turn out extremely well. This is important for you to understand because derivatives are tools for hedging. If you are willing to take risk and speculate, you make big money but there is equal chance of losing big money.
Secondly, derivatives help discover price of an asset. How will you decide what price to pay for a stock of a company? The price of a stock in Capital Market segment follows the price of a derivative on the stock of the same company. However, sometimes vice-versa is also true.
Thirdly, derivatives have become a very important tool in today’s market where businesses, exchanges, banks, and financial centers are connected. The trade among countries has multiplied but that has also given rise to risk of currency, inflation, and interest rate. Derivatives can be used to hedge many of these risks.
Lastly (and there will be certainly more), derivatives are an innovative financial products. There is no risk, no scenarios, which derivatives cannot take care. The sheer opportunity for product innovation in the area of derivatives has given it a formidable size in today’s market. As an estimate, in the peak time of 2008, there were more than $60 trillion derivatives in the market. This is much more than the GDP of the world.
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Pankaj Priyadarshi
Pankaj Priyadarshi is an author at Lastbull.com. He has 11 years of international and domestic experience in the areas of Finance, Management, and Business Analysis in the USA and India.He is a co-founder of 'Vertical Grass', a consulting initiative in the area of finance. A Graduate from IIT(Engineering) and ISB(Management).
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