Education

What Are Derivatives?

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Derivatives are financial instruments whose value derives from the evolution of the prices of other assets called underlying assets. The underlying assets used can be very varied: stocks,, fixed income securities, currencies, interest rates, stock indices, commodities, and more sophisticated products, including those involving inflation or credit risk.

But what lies behind this definition? The crux of the matter lies in the way in which the price is derived, and in the nature of the transaction to which this instrument gives rise. That is, how and when the asset is exchanged for its value or price in money.

In regular cash or spot operations, such as when we go to the supermarket, the exchange of the product for its price is made at the time of the agreement. However, a derivative is a pact whose terms are set today but, and here is the difference, the transaction is made at a future date.

This idea of ​​agreeing a sale that will materialize after a certain time has as much antiquity as the trade itself; In the financial markets of the seventeenth century, the Dutch were already negotiating derivative contracts whose assets were tulip bulbs. Yep, the first organized markets. Contracts were structured and priced to include the future delivery of rice. The parties would know what price was going to be charged and paid for a harvest for well in advance, leading to a calmer market. In this example, both bulbs and rice are the underlying asset.

It was not until the 19th century when the first modern derivatives market was born in Chicago, where even today, contracts are traded whose assets are wheat and maize.

They were subsequently extended to other underlays, and organized commodity markets were established in other countries. In 1973, also in Chicago, the first contract was created that allowed one to secure an exchange rate for a future date; It is, therefore, the birth of the financial derivative. This was followed by other derivatives that allowed the trading of financial assets such as stocks, bonds, indices, interest rates, etc.,

In summation, therefore, derivative products serve to shift the risk of agents (who wish to sell it) to others (who want to buy it), which allows them to be used for opposing purposes.

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