economics

Derivatives Markets : Basics

Derivatives are financial instruments whose value are derived from the
performance of assets, interest rates, currency exchange rates, or indexes. The
main types of derivatives are futures, forwards, options and swaps.

Derivatives Basics Definitions - Types of Derivat

Types Futures Exchange Traded: Standardizati
Forwards OTC-Traded; Futures vs. Forwar
Options Types of Options (OTC-, Exchan
Swaps OTC-, Exchange Traded - Types

Examples Credit Derivatives - Types: CDS, CDOs
Weather Derivatives: Types of Weather

Derivatives Markets - Types: Futures

Futures contracts, are exchange traded derivatives. The contracts are
standardized and traded on a futures exchange, to buy or sell a certain underlying
instrument at a certain date in the future, at a specified price.

Forward contracts, are agreements between two parties to buy or
sell an asset (of any kind) at a pre-agreed future point in time.
The trade date and delivery date are separated.

A forward contract is used to control and hedge risk, for example
currency exposure risk (e.g. forward contracts on USD or EUR) or
commodity prices (e.g. forward contracts on oil). ...below



Option: A privilege sold by one party to another that offers the
buyer the right, but not the obligation, to buy (call) or sell (put) a
security at an agreed-upon price during a certain period of time or
on a specific date.


Exchange-traded options form an important class of options which
have standardized contract features and trade on public exchanges,
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facilitating trading among independent parties.


Swap: A derivative in which two counterparties agree to exchange one stream of
cash flows against another stream. These streams are called the legs of the swap.

Capital Markets
Capital markets are perhaps the most widely followed markets. Both the stock and
bond markets are closely followed and their daily movements are analyzed as
proxies for the general economic condition of the world markets. As a result, the
institutions operating in capital markets - stock exchanges, commercial banks and
all types of corporations, including nonbank institutions such as insurance
companies and mortgage banks - are carefully scrutinized.

The institutions operating in the capital markets access them to raise capital for
long-term purposes, such as for a merger or acquisition, to expand a line of
business or enter into a new business, or for other capital projects. Entities that are
raising money for these long-term purposes come to one or more capital markets.
In the bond market, companies may issue debt in the form of corporate bonds,
while both local and federal governments may issue debt in the form of government
bonds. Similarly, companies may decide to raise money by issuing equity on the
stock market. Government entities are typically not publicly held and, therefore, do
not usually issue equity. Companies and government entities that issue equity or
debt are considered the sellers in these markets.

The buyers, or the investors, buy the stocks or bonds of the sellers and trade them.
If the seller, or issuer, is placing the securities on the market for the first time, then
the market is known as the primary market. Conversely, if the securities have
already been issued and are now being traded among buyers, this is done on
the secondary market. Sellers make money off the sale in the primary market, not
in the secondary market, although they do have a stake in the outcome (pricing) of
their securities in the secondary market.
The buyers of securities in the capital market tend to use funds that are targeted
for longer-term investment. Capital markets are risky markets and are not usually
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used to invest short-term funds. Many investors access the capital markets to save
for retirement or education, as long as the investors have long time horizons, which
usually means they are young and are risk takers.

Money Market
The money market is often accessed alongside the capital markets. While investors
are willing to take on more risk and have patience to invest in capital markets,
money markets are a good place to "park" funds that are needed in a shorter time
period - usually one year or less. The financial instruments used in capital markets
include stocks and bonds, but the instruments used in the money markets include
deposits, collateral loans, acceptances and bills of exchange. Institutions operating
in money markets are central banks, commercial banks and acceptance houses,
among others.

Money markets provide a variety of functions for either individual, corporate or
government entities. Liquidity is often the main purpose for accessing money
markets. When short-term debt is issued, it is often for the purpose of covering
operating expenses or working capital for a company or government and not for
capital improvements or large scale projects. Companies may want to invest funds
overnight and look to the money market to accomplish this, or they may need to
cover payroll and look to the money market to help. The money market plays a key
role in ensuring companies and governments maintain the appropriate level of
liquidity on a daily basis, without falling short and needing a more expensive loan
or without holding excess funds and missing the opportunity of gaining interest on
funds.

Investors, on the other hand, use the money markets to invest funds in a safe
manner. Unlike capital markets, money markets are considered low risk; risk-
adverse investors are willing to access them with the anticipation that liquidity is
readily available. Older individuals living on a fixed income often use the money
markets because of the safety associated with these types of investments.

The Bottom Line
There are both differences and similarities between capital and money markets.
From the issuer or seller's standpoint, both markets provide a necessary business
function: maintaining adequate levels of funding. The goal for which sellers access
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each market varies depending on their liquidity needs and time horizon. Similarly,
investors or buyers have unique reasons for going to each market: Capital markets
offer higher-risk investments, while money markets offer safer assets; money
market returns are often low but steady, while capital markets offer higher returns.
The magnitude of capital market returns is often a direct correlation to the level of
risk, however that is not always the case.

Although markets are deemed efficient in the long run, short-term inefficiencies
allow investors to capitalize on anomalies and reap higher rewards that may be out
of proportion to the level of risk. Those anomalies are exactly what investors in
capital markets try to uncover. Although money markets are considered safe, they
have occasionally experienced negative returns. Inadvertent risk, although unusual,
highlights the risks inherent in investing - whether long or short term, money
markets or capital markets.
Commodity. Commodities are bulk goods and raw materials, such as grains, metals, livestock,
oil, cotton, coffee, sugar, and cocoa, that are used to produce consumer products.
The term also describes financial products, such as currency or stock and bond indexes.
Commodities are bought and sold on the cash market, and they are traded on the futures
exchanges in the form of futures contracts.
Commodity prices are driven by supply and demand. When a commodity is plentiful -- tomatoes
in August, for example -- prices are comparatively low. When a commodity is scarce because of
a bad crop or because it is out of season, the price will generally be higher.
You can buy options on many commodity futures contracts to participate in the market for less
than it might cost you to buy the underlying futures contracts. You can also invest through
commodity funds
Definition of 'Equity Financing'

The process of raising capital through the sale of shares in an enterprise. Equity
financing essentially refers to the sale of an ownership interest to raise funds for
business purposes. Equity financing spans a wide range of activities in scale and
scope, from a few thousand dollars raised by an entrepreneur from friends and
family, to giant initial public offerings (IPOs) running into the billions by household
names such as Google and Facebook. While the term is generally associated with
financings by public companies listed on an exchange, it includes financings by
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private companies as well. Equity financing is distinct from debt financing, which
refers to funds borrowed by a business.

Definition of 'Shares'

A unit of ownership interest in a corporation or financial asset. While owning shares
in a business does not mean that the shareholder has direct control over the
business's day-to-day operations, being a shareholder does entitle the possessor to
an equal distribution in any profits, if any are declared in the form of dividends. The
two main types of shares are common shares and preferred shares.
Definition of 'Debenture'

A type of debt instrument that is not secured by physical assets or collateral.
Debentures are backed only by the general creditworthiness and reputation of the
issuer. Both corporations and governments frequently issue this type of bond in
order to secure capital. Like other types of bonds, debentures are documented in an
indenture.

Definition of 'Bond'

A debt investment in which an investor loans money to an entity (corporate or
governmental) that borrows the funds for a defined period of time at a fixed
interest rate. Bonds are used by companies, municipalities, states and U.S. and
foreign governments to finance a variety of projects and activities.

Bonds are commonly referred to as fixed-income securities and are one of the three
main asset classes, along with stocks and cash equivalents.

Definition of 'Derivative'

A security whose price is dependent upon or derived from one or more underlying
assets. The derivative itself is merely a contract between two or more parties. Its
value is determined by fluctuations in the underlying asset. The most common
underlying assets include stocks, bonds, commodities, currencies, interest rates and
market indexes. Most derivatives are characterized by high leverage.

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Definition of 'Bull Market'

A financial market of a group of securities in which prices are rising or are expected
to rise. The term "bull market" is most often used to refer to the stock market, but
can be applied to anything that is traded, such as bonds, currencies and
commodities.

Bull market:-
bull market is when the market appears to be in a long-term climb. Bull markets
tend to develop when the economy is strong, the unemployment rate is low, and
inflation is under control. The emotional and psychological state of investors also
affects the market. For example, if investors have faith that the upward trend in
stock prices will continue, they are likely to buy more stocks. If there are more
buyers interested in buying shares at a given price than there are sellers who are
willing to part with their shares at that price, stock prices will continue to rise.

Bear Market

A bear market describes a market that appears to be in a long-term decline. Bear
markets tend to develop when the economy enters a recession, unemployment is
high, and inflation is rising. Investors lose faith in the market as a whole, which in
turn decreases the demand for stocks. Keep in mind that a sustained bear market is
something that you should expect to occur from time to time, and that, in the past,
the stock market has risen more than it has declined.