Global derivatives are financial contracts between buyers and sellers for future payment and delivery of an underlying asset. During the life of the contract, the value of the derivative fluctuates with the value of the asset. Global derivatives are mainly used to protect against and manage risk. They also can be used for speculation and investment purposes.
There are two types of global derivatives. The over-the-counter (OTC) derivative is an off-exchange product traded through a network of dealers. The exchange-traded derivative is a standardized contract traded on a formal futures exchange. The exchange provides trading rules and regulations. Counter-party risk is eliminated on futures exchanges through a clearing house.
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Commodity, currency and interest rate derivatives are by their very nature global derivatives. Commodities such as gold and oil are traded globally. World currencies are traded virtually around the clock. Commodities and currencies can be traded on futures exchanges. Options on these assets can be traded on or off exchange.
A majority of the world's largest corporations manage risk using global derivatives. Corporations and financial institutions manage risk against changes in currency exchange rates, raw material prices and interest rates. Hedging market risk eliminates future uncertainty providing insurance against volatility and price changes.
Derivatives provide the market speculator a means to enter long and short positions without actual ownership of an asset. The ability to control a large capital asset with a modest investment exists because of the leverage provided by derivatives. The speculator can trade on future price expectations and incorporate strategies that are not possible when trading hard assets.
The OTC segment of the global derivatives market is much larger than the exchange traded version. Exchange traded derivatives are the faster-growing segment because of the standardization of contracts. The advantages of exchange trading are price transparency, risk mitigation and lower transaction costs.
Global market efficiency and trading might not be possible without global derivatives. Derivative markets are safe and efficient. There is room for improvement in risk mitigation procedures in the OTC derivative segment. The financial derivatives market is the largest market in the world and truly enables a global marketplace.