What Is A Derivative?
a derivative is a contract between two or more parties ? it is based on or ? from an agreed upon asset. the parties included in the derivative decide what the asset will be. common assets are stocks, bonds, currencies, interest rates and commodities. originally, derivatives were used to ensure a balanced exchange rate for goods traded internationally. for example, a u.s. company sends a ? of goods to the u.k. the u.s. company would create a derivative with an investor that guarantees the exchange rate is ? to all parties. if the exchange rate dips and the investor in the derivative speculated that the exchange rate will remain stable or in favor of the u.s. company, the investor will lose money. however, the u.s. company would still be paid value of their goods. if the exchange rate grows, the investor will make a profit from speculation and the u.s. company will be paid value of their goods. today, many corporations use derivatives to gain favorable interest rates on loans to better manage corporate debt. this gives corporations more borrowing power for growth and investment. however, derivatives are not without risk. huge losses can occur with even a small change in the price of the asset that derivatives are based upon. although usually based on a monetary asset, derivatives can also be based on any product agreed upon by two parties. derivatives today are based on a wide range of transactions from wheat prices and gold to even the weather.