1. Financial Derivatives
Deekshya Bajracharya

2. Definition of Financial Derivatives
A financial derivative is a contract between two (or more) parties where payment is based on (i.e., "derived" from) some agreed-upon benchmark.
Since a financial derivative can be created by means of a mutual agreement, the types of derivative products are limited only by imagination and so there is no definitive list of derivative products.
Some common financial derivatives, however, are described later.
More generic is the concept of “hedge funds” which use financial derivatives as their most important tool for risk management.

3. Repayment of Financial Derivatives
In creating a financial derivative, the means for, basis of, and rate of payment are specified.
Payment may be in currency, securities, a physical entity such as gold or silver, an agricultural product such as wheat or pork, a transitory commodity such as communication bandwidth or energy.
The amount of payment may be tied to movement of interest rates, stock indexes, or foreign currency.
Financial derivatives also may involve leveraging, with significant percentages of the money involved being borrowed. Leveraging thus acts to multiply (favorably or unfavorably) impacts on total payment obligations of the parties to the derivative instrument.

4. Common Financial Derivatives
Options
Forward Contracts
Futures
Stripped Mortgage-Backed Securities
Structured Notes
Swaps
Rights of Use
Combined
Hedge Funds
A Brief Guide to Financial Derivatives

5. Futures
A Future is a contract to buy or sell a standard quantity and quality of an asset or security at a specified date and price.
Futures are similar to Forward Contracts, but are standardized and traded on an exchange, and are valued daily. The daily value provides both parties with an accounting of their financial obligations under the terms of the Future.
Unlike Forward Contracts, the counterparty to the buyer or seller in a Futures contract is the clearing corporation on the appropriate exchange.
Futures often are settled in cash or cash equivalents, rather than requiring physical delivery of the underlying asset.

6. The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his contract.
In real life, the actual delivery rate of the underlying goods specified in futures contracts is very low as the hedging or speculating benefits of the contracts can be had largely without actually holding the contract until expiry and delivering the good.

7. Futures contracts are used by two categories of market participants: hedgers and speculators. Producers or purchasers of an underlying asset hedge or guarantee the price at which the commodity is sold or purchased, while portfolio managers or traders may also make a bet on the price movements of an underlying asset using futures.