Features of Financial Derivative

The following are the main features of financial derivatives:

1) The transactions in derivatives are separate from the transactions in the underlying securities.

2) The financial derivative is priced according to the value of the underlying asset.

3) Financial derivatives are used for a wide variety of reasons such as hedging, risk management, and in many cases, for speculation.

4) The settlement of derivatives generally takes place through the net payment of cash. It is also generally done before the maturity date.

5) Financial derivatives allow for geared returns, which are generally higher than the returns made by investing’ in the underlying.

However, it also increases the risk. For example, paying the premium is all that is required to invest in options. The potential returns can be substantial.

6) The risk involved with derivative trading may be mitigated through trading or through the contract. The offset ability of the derivatives can be achieved through the use of options of Other hedging activities.

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