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hello and welcome today we will be providing a brief introduction to financial derivatives this video is intended to only to provide a general picture of what derivatives are the four most common types of derivatives will be examined in greater detail and standalone videos in the coming weeks so what exactly is a financial derivative well it's most general sense a derivative is a contract whose value is based on something else but more specifically the term financial derivative refers to any security whose value is determined by or derived from the value of another asset the asset from which a derivative gets its value is known as the underlying asset or simply underlined an underlying asset can take many forms but it commonly refers to stocks bonds commodities currencies interest rates and market indexes the most important thing to take away from our discussion of derivatives so far is that their value depends upon the value of something else the underlying asset so the change in the value of a derivatives underlying cause the change in the value of the derivative itself this is all well and good but what's the point of derivatives well there are two main uses for derivatives the first is to hedge risk derivative hedging generally refers to the practice of using derivatives for the objective of minimizing risk in the physical market in order to demonstrate how a rivet of can be used to hedge risk consider the example of wheat producers and cereal manufacturers hedging their exposure to fluctuations and wheat prices as we know weed is susceptible to significant fluctuations in price owing to both supply and demand fall on the price of wheat is bad for wheat producers because they can get less money from the crops but it's good for cereal manufacturers because they can get one of their key inputs at a discount on the other hand an increase in the price of wheat is good for wheat producers because they can get more money for their crops but is bad for cereal manufacturers because it increases costs so it is in the interest of wheat farmers that the price of wheat remains hot but it is in the interest of cereal manufacturers that the price of wheat remains low now if a wee producer expects that the price of wheat is about to fall and a cereal manufacturer is of the opinion that the price of wheat is about to rise the two parties can enter into a contract fixing the future price at which the wheat will be sold for example a wheat producer might agree to sell wheat to a manufacturer in six months at the current market price of $12 regardless of what the market price for wheat is in six months by locking in the price of wheat the producer is seeking to protect his or her self against an expected decrease in the price of wheat on the other hand the manufacturer is seeking to protect his or herself from an expected increase in the price of wheat if the price of wheat falls the cereal manufacturer or buyer will wish that they hadn't signed the contract because they could be buying wheat for cheaper had they not signed it conversely if the price of wheat Rises the producer or seller will wish that they hadn't signed the contract because they could be selling wheat for more money had they not agreed to the contracts terms because the price of wheat can only move in two directions up or down this example is a zero-sum game possessing both a distinct winner and a distinct loser basically the interest of only the wheat producer or the cereal manufacturer can be met not both so in this example Ford contract was used by both wheat sellers and we buyers in an effort to hedge price risk by locking in the price of week we will discuss forward contracts in greater detail in another video but what is most important to take away from this example is the derivatives can be used to hedge risk the second main use of derivatives is speculation derivative speculation is fundamentally different from derivative hedging where derivative hedgers are trying to reduce their risk exposure and usually are not motivated by profit in the derivative market itself derivative speculators are motivated purely by profit seeking basically petra seek to limit risk by using derivatives as insurance policies while speculators are directly driven by the opportunity for profit now that we have a basic understanding of how derivatives are used let's take a look at the different types there are four main types of derivatives forwards futures options and swaps each of these concepts will be addressed in greater depth in future videos here our aim is only to provide a basic overview with this in mind let's begin with forward contracts a forward is the customized contract between two parties to buy or sell an asset at a specified price at a specified future date forwards are not traded on a central exchange and as a result they're not standardized to regulate making them particularly useful for hedging futures contracts are fundamentally similar to forwards however unlike forwards they are standardized and regulated so that they may be traded on a futures exchange futures are often used to speculate on commodities an options contract is a contract to give the right but not the obligation to buy call or sell put a security or other financial asset finally swap is fairly self-explanatory and refers to the exchange of one security for another based on different factors so we have seen the derivatives our contract whose value is based on something else we have seen that they can be used for either hedging or speculating and we have briefly touched on the four main types this brings our overview of financial derivatives to a close but please stay tuned for our videos on forwards futures options and swaps thanks for watching and as always if you have any further questions please do not hesitate to give us a call or visit our web site