Derivatives Markets – Financial engineering can be defined as the development and creative application of financial techniques for solving financial problems, exploiting investment opportunities, and to add value. Financial transactions and investment activities particularly in securities as well involve uncertainty. Fluctuations in the financial assets expose to risk. The investors particularly dealers are supposed to hedge risk involved in their financial transactions. Hence, it is necessary for the investors, market makers and financial management concerned to have basic understanding about proper risk management tools. Financial derivatives are widely used tools in this regard.
Financial derivatives can be defined as instruments for hedging the risk involved in buying, holding, and selling different types of financial assets like shares, stocks etc. Broadly speaking they refer to financial assets/instruments for the management of risk arising from the uncertainty prevailing in the transactions of financial assets. Financial derivatives are, therefore, evolved to hedge the risk while dealing in the financial assets. They are commonly known as derivative securities since their values are derived from the underlying assets. Finally, financial derivatives are designed help providing financial protection to participants in the financial markets against adverse movements in the price of the underlying assets. They facilitate in transactions of financial assets at or within a predetermined future date at the price determined today. The values of the financial derivatives are derived from the performance of the financial assets, interest rates, currency exchange rate, stock market indices, and what not.
A financial derivative can also be defined as a contract specifying the rights and obligations between the issuer of financial derivatives and the holder thereof to receive or deliver future cash flows based on some future events. Some derivatives are traded or transacted on organized stock exchanges which are known as exchange-traded derivatives like options, warrants, futures. Other derivatives known as over-the-counter derivatives are not transacted in the organized stock exchange but are privately negotiated between the parties.