Derivatives

Derivative products are a family or set of financial instruments whose primary characteristic is that they are linked to an underlying or reference value or asset. Derivative products emerged first as instruments for hedging against fluctuations in the price of agro-industrial products (commodities) under conditions of extreme volatility.

Financial derivatives

Beginning in 1972, the family of derivatives instruments began to expand briskly, to include a new set of reference assets such as securities representing equity or fixed income, indices, interest rates, currencies and other financial instruments. The most common financial derivatives are futures, options, and swaps.

Futures

These are instruments that allow us to fix the purchase and/or sale price of a product (for example, a currency, a stock, etc.) today, for payment and delivery on a future date. Because they are standardized in terms of the size of the contract, the maturity date, form of settlement and negotiation, they can be listed on a derivatives exchange.

Options

A standardized contract in which the option buyer pays a premium and acquires the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a specific price on a specified future date. The option seller is obliged to perform the opposite action of the contract if the buyer exercises this right.

Swaps

Derivative instruments that allow for the exchange of periodic interest payments (for example fixed-rate for variable-rate) or positions in various maturities and/or currencies.

Underlying Assets

The most commonly used underlying assets for financial derivative contracts are interest rates, stock indices, individual stocks, and foreign currencies.

Advantages of financial derivatives

The main purpose of derivatives is to serve as a hedge against fluctuations in the price of the underlying asset. For this reason, they are applied preferably to:
• Stock portfolios.
• Obligations taken on at an adjustable rate of interest.
• Payments or collections in foreign currency at a specified term.
• Cash flow planning; and others.

Derivative products are instruments that contribute to the liquidity, stability and depth of the financial markets, and to generate conditions for diversifying investment and managing risk.

Some of their uses are:

Currency contracts

• If you have future payments or collections in foreign currencies.
• If you acquire equipment payable in other currency.
• If you are importing or exporting different goods.

Interest rate contracts

• If you want to hedge against an increase or decrease in interest rates.
• If you take out a loan at a floating rate, and you wish to fix the interest rate.
• If you want to ensure a specific return on an investment.

Contracts on stock indices or individual stocks

• If you want to hedge against potential losses in stock portfolios.
• If you want to perform an advanced purchase of stocks when you have no cash flow today.
• If you want to profit when the market declines, and simulate short sales.