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Tuesday, December 29, 2009

Project Report on Derivatives

Derivatives, such as options or futures, are financial contracts which derive their value of a spot price time-series, which is called the under-lying". For examples, wheat farmers may wish to contract to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction would take place through a forward or futures market. This market is the derivative market” and the prices on this market would be driven by the spot market price of wheat which is the underlying". The terms contracts" or products" are often applied to denote the specific traded instrument. The world over, derivatives are a key part of the financial system. The most important contract- types are futures and options, and the most important underlying markets are equity, treasury bills, commodities, foreign exchange and real estate.

Derivatives—contracts that gamble on the future prices of assets--are secondary assets, such as options and futures, which derive their value from primary assets, such as currency, commodities, stocks, and bonds. The current price of an asset is determined by the market demand for and supply of the asset; however, the future price of an asset typically remains unknown. A week or a month in the future, the price may increase, decrease, or remain the same. Buyers and sellers often like to hedge their bets against this uncertainty about future price by making a contract for future trading at a specified price. The contract—a financial instrument--is called a derivative.

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