The article concerns the question – What Are Financial Derivatives? Derivative is a financial instrument that is commonly utilized in a large scale in the present day stock exchanges. Trading in the stock market is a risky matter. If you are not careful enough, you can lose considerable sums. It can leave you with a disheartening experience. Financial derivatives might be a respite to escape from such complications.
In a conventional stock exchange, the buyer will have to commit a particular amount to the seller in return of a few shares or stocks. The price of these financial securities might falter or rise in the coming days. You will have to master the niche of stock picking in order to avoid financial problems. If you wish to trade using derivatives, you can commit for a certain number of shares by paying a small fraction of the original cost to the seller. The agreement will outline a date before which the buyer can choose to purchase or give away the earlier committed shares.
How is the entire paradigm feasible to the buyer? Firstly, he can confide groups of stocks for a marginal price instead of shelling out thousands. The fate of these shares is largely undecided and the buyer must pay the rest of the amount and purchase the shares at a future date. He also gets the additional immunity from a sharp increase in the price of the shares.
As you might already know, stock market is a highly volatile market. The prices of stocks are known to vary by the minute. In such a scenario, financial derivatives will act out as a boon to the buyer! Without paying the complete amount, they can secure a good number of shares.
Some of the readers might begin to think from the seller’s perspective. How are financial derivatives helpful to this lot? Instead of awaiting someone to turn up and purchase a set of shares, they can enjoy assuring sale of the shares. The seller is still making a profitable sum if at all the buyer refuses to pay up the rest of the committed amount.
Consider it like this. You wish to purchase something from the nearest shop. You can visit the shop straightaway and buy it. Alternatively, you can call the shopkeeper and ask him to withhold the sale of the particular product – while agreeing to purchase it eventually. The same strategy is applied in this domain too.
Financial derivatives need not always turn out to be feasible for both the parties. There have been numerous instances when companies were forced to file for bankruptcy due to flawed financial derivative practices. Some of the notable and reputed stockbrokers tend to keep away from derivatives when they begin to consider such happenings.
However, from the viewpoint of an inexperienced trader, financial derivatives work out to be highly lucrative. He can resume his trading habits without making a significant dent on his savings. As a rule, it is better to learn the layout of stock market trading before jumping ships.