Derivative Instruments – Features and Implications

Features of derivative instruments and its implications have been scripted in the article below. The article also furnishes information about the trading of derivative instruments in different jurisdiction.
Derivative instruments are contracts or agreements, which provides right, obligations to contracting members on the basis of certain underlying interest.

The obligations or rights contained in a derivative contract pertaining to an underlying interest may be in the form of:

  • Cash settlement
  • Delivery of
  • Transfer of rights

Types Of Derivative Instruments That Are Traded

As far as the underlying interests pertaining to different derivative instruments are concerned, they may be commodities, which may include wheat, gold and other similar commodities. These commodity-trading products fall in the category of physical assets.
Other derivative instruments may include equity indices or equities. Various debt instruments are also included. Another category of derivative instruments, which may determine the underlying interest, is a pricing index. The pricing index may be considered over a period of time. The nature of the underlying interest does not alter the characteristics of a derivative instrument. It may be a commodity or a financial instrument.

Options Of Having Multiple Contracts

The derivative contract itself does not get transferred or does not imply a transfer of any underlying interest. However, transfer takes place as part of a separate transaction, in the event when the contract is not made null and void (offset). Since there is no actual transfer of derivative instrument, at any given point of time, there may be several contracts pertaining to any derivative instrument.

Features Of Derivative Instruments And Its Implications In Different Jurisdiction

As a rule, the derivative instruments are “standardized” on exchange, which are organized. In the event when trading of underlying interest takes place in an area (jurisdiction) where the derivative instrument is not being traded, there may be chances of manipulation. Another instance when there may be manipulation is when trading of similar derivative instruments take place in two different areas (jurisdictions).

Derivative instruments help in shifting risk. It also helps in price discovery pertaining to underlying interest. Prices prevailing in the derivative markets can impact price of underlying interest and this can also happen the other way round.

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