Derivatives Paper

Derivatives are not the easiest financial instruments to understand and they can definitely get very complex. Regardless, derivatives have a long-standing history and have grown in popularity in the financial sector. Some would be surprised to learn that derivatives actually arose many, many centuries ago and are not something that just came into importance in the last few decades. In history, derivatives have evolved into what they are today. Previously, farmers primarily utilized derivatives because they saw great risk in farming certain crops especially crops that were hard to harvest in certain areas (Chance 7). Some say though that derivatives can be traced all the way back to biblical times but it is more feasible to look at the history in the past couple of centuries (“A Brief History of Derivatives” 6). In 1570, the Royal Exchange opened in London for forward contracting and in 1690, options began trading on securities in London. It was not until 1790 though that options began trading on securities in the United States (“A Brief History of Derivatives” 6). Today, numerous companies utilize many different kinds of derivatives on several financial markets. So what exactly is a derivative? A derivative is an agreement regarding an underlying asset over a span of time, the value of which is derived from the performance of the underlying asset (Greenwald 28). Thus, a derivatives transaction is any "financial contract under which either or both of two parties agree to make payments or deliveries to the other based on the performance or change in the value of a reference rate or asset" (Greenwald 28). The underlying reference rate or asset is typically an interest rate, currency exchange rate, or a tangible commodity. Although this is typical, the underlying reference rate or asset could really be anything that is quantified and objectively verifiable (Greenwald 29). For example, an interest rate swap derives its value from one or more interest rate

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