Origin of Derivative Instruments

Origins of Derivative Instruments can be traced back to Sixth Century B.C. Renowned philosopher of Greece; Thalus is thought to be the first person that had formulated an agreement, which is very similar to that of option derivative of today, for making profit.
Derivatives are advanced financial instruments whose values are dependent on one or many assets, known as underlying assets. These are nothing but contracts between two or more people.

Value of a derivative changes with price change of its underlying asset (share, commodity, currency and many more).

Some of these instruments are: –
Forward Contract
Futures
Options
History of Derivative Instruments. Derivative Instruments are used by traders either for hedging purposes or for leveraging their profit through speculation.
Origins of Derivative Instruments are given in a chronological manner:
6th Century B.C.
Thalus, a Greek Philosopher, instrumented an agreement by which he secured the rights of the olive presses. He was able to secure the same at a comparatively low rate because of the uncertainty relating to the extent of harvest. Olive harvest for that year was very high which generated excess demand for olive presses. This gave Thalus the opportunity to charge a very high price from the consumers and consequently book a heavy profit.
12th Century
During the 12th century, trade flourished in Europe. The merchants had to ship their goods from one part of the continent to another in search of profit. But this process bore risk of shipwreck and consequent loss. In order to bypass this problem these merchants came out with “letter de faire” which were nothing but customized forward contracts. These letters acted as evidence of the deals between the customer and the merchant. In turn, the merchant remained obliged for making delivery of the traded commodity whenever the customer asks for it. After some time of its initiation, the merchants started trading of these commodities among themselves.
17th Century
In Japan, the feudal lords used to issue storage tickets on surplus rice, which promised delivery of the same at a future date. These tickets in turn were also traded in the rice market of Dojima.
19th Century
Derivative instruments were formulated in the early part of the 19th century and were primarily restricted to Chicago, USA. Need for such instruments cropped up due to seasonal fluctuations in agricultural production, which heavily depended on the vagaries of nature. Farmers and traders started to device forward contracts on agricultural produce from this time around in order to hedge their risk from irregularities in production.
20th Century
More and more derivative instruments were invented in this century and their popularity increased tremendously. Some of the factors behind this popularity are:

1. Dismantling of fixed exchange rate system

2. Invention of theoretical basis of Options, namely Black-Scholes formula

Conclusion
Derivatives were utilized in the financial markets around the world from quite a long time whose origin can be traced back to 6th century B.C. With the passage of time, the need of these instruments increased among various sections of the society for hedging purposes. Later, the speculative motive of the investors also surfaced and led to its popularity.

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Last Updated on : 1st August 2013

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