A brief introduction, definition and practical examples of Derivative:
Have you noticed that the word “derivative” is becoming a part of our common language and routine talks? But perhaps you may not come across any explanation writings about this word and that’s why we don’t know its importance, uses and types in daily routine. By reading this writing, hopefully you will learn a lot more things that you didn’t know before. It will enhance your knowledge and make you able to share your knowledge with your social circle.
The derivative is a financial instrument that denotes an inconsiderable variation in the functions w.r.t one of the variables i.e. market securities, interest rates, credit charges and exchange rates.
What does mean by the word“Derivative” in general?
If the value of one thing is based on another thing, it is called derivative. In short we can say the first thing is based on the other thing. For example, when a person tries to extend his conversation based on facts and figures. We can say that his arguments are based on or derived from facts.
Explanation with practical examples:
When a person goes to buy stock or shares through call option, they are provided with an opportunity to buy stock at present rates, and these rates depend upon the face value of underlying stocks. So it gives a meaning that stocks rates are derived from the market face value.
If you buy some shares of ABC Company, we will observe that the rate of fluctuation of profit or loss of shares would entirely depend on the company’s market reputation and standing. Hence we can conclude that the value of your shares is derived from the company dealings.
If you see towards agriculture sector and industry connection, we can observe that their success is derived from each other. For example, if a farmer cultivate beans of good quality and sell on nominal price to a coffee making company. The company will consider him for building a long term relationship as a supplier. Prospects of contract are derived on quality provide by farmers. Proceeding with the same example, that company will make high quality products out of beans and sell at market and relatively lower prices than other competitors. The customers will be more attracted towards the good quality and low prices. Hence, it will gain more success and market share. In short, it is explaining the definition of derivative, how the success of coffee makers is derived from beans cultivation.
Why do people consider Derivatives Risky?
The risk is of two types. One is systematic risk and other is unsystematic risk. If we will be able to introduce systematic risk in our economy then derivatives can provide assistance to flourish the economy by reducing risk in different aspects. Only a cluster of a few corporations embodies a substantial share of total derivatives of the world. It is given a meaning that if one of these few corporations will be insolvent or bankrupt, it will adversely affect the financial system of the whole Economy.