Talk:Derivative (finance)

Introductory section

I'm having a hard time even parsing some of these sentences, and I don't see how a reader could arrive at a crisp understanding of a 'derivative security'. For example, I can't find meaning in the sentence 'The economic derivative product embedded into either of the above or into a derivative security may be the same or different, as the differences between these three products are in their legal form.' Can someone help me discover what the writer is trying to say?

"Other financial derivatives do not take the form of securities but are in the form of a bi-lateral contract that can be bought "over-the-counter" or through an exchange. The economic derivative product embedded into either of the above or into a derivative security may be the same or different, as the differences between these three products are in their legal form."

Thats sentence is confused. A derivative is bi-lateral, an agreement between two parties. Instead of "legal form" it should say, the contract can have a myriad properties. - Jerryseinfeld 01:56, 22 Dec 2004 (UTC)

The introduction is horrible. After reading it I still had no clue of what on earth a derivative was. Reading the first few lines of Forward_contract, Futures_contract, Option_(finance) and Swap_(finance) served as a much better introduction than the intro in this article. The word "future" is used only once in the intro and only refers to another article.

I think that it would be good if someone with a decent understanding of the subject matter were to rewrite the intro. --75.152.169.231 (talk) 21:32, 29 March 2009 (UTC)

I have a college education and while I can read the text I have absolutely no idea what the introduction is saying and I can only barely vizualize what a derivative is. Can someone please explain better? I would hope someone can explain this as it is what caused a lot of our economic problems in fy 2007-2009 in the US. --- I found this really sweet video that explains a derivative and talks about some of the risks -- http://www.youtube.com/watch?v=XtznP6DFo-U ---68.109.156.229 (talk) —Preceding undated comment added 20:44, 5 January 2010 (UTC).

I agree I still have no idea what any of this means68.28.105.230 (talk) 08:46, 8 January 2010 (UTC)

I am planning to move/integrate the section under "Uses" namely hedging and speculation to their relevant pages rather than duplicating it here under derivatives. If you disagree please record your arguments here. 41.243.15.94 (talk) 14:48, 27 February 2010 (UTC)

Are you going to create new sections in this article on those topics or are you going to create new sections in this article on uses/hedging/speculation? Also, it would be useful if you signed your posts with your user name. Bond Head (talk) 12:43, 28 February 2010 (UTC)

My idea is to list and briefly describe the different uses and also to make sure a more comprehensive discussion is done on the separate linked pages e.g. hedging. The main purpose of this page would be to set the broad overview of derivatives while more specific issues/subjects are addressed elsewhere. Apologies for not signing my name. Swerfvalk (talk) 08:27, 1 March 2010 (UTC)

Bigfatloser wrote in the defenition: "Essentially, it is a binding contract for a person to buy or sell an asset at some point in the future, but the person is paying for it in the present. So in essence, it is the right of one group to buy or sell from another party at a locked in price." This is factual incorrect: 1.) Not all derivatives are binding contracts. e.g. options 2.) Derivatives are not necessarily on assets. e.g. weather derivatives 2.) The derivative premium and payment for the underlying is seldomly done in the present. Swerfvalk (talk) 16:41, 24 March 2010 (UTC)

Eh, good points, but once you say the derivative is a contract (but not necessarily "binding" on both parties) and that the underlying can be anything that is quantifiable and whose behavior can be judged in an objective manner, you have a good start to a definition. In any case, I've put in something similar in the lede now. Yeah I know, Hull's "definition" was there, but he has the benefit of explaining at length and leisurely for the rest of his textbook what derivatives are. Telling the Wikipedia reader that a derivative is basically something that derives value from other things isn't so useful. --DudeOnTheStreet (talk) 14:39, 19 April 2011 (UTC)

I agree with Swerfvalk's 1 March statement: remove all the jargon and complex definitions and create links to pages specifically for bonds, cdo, irswaps etc. Try to refine (or lessen) all of that complicated terminology out. It is probably too short of an explanation, but the real definition is something like Derivative: a financial arrangement derived from a financial arrangement, mostly intangible. It's kind of like asking "What is a job?" (and is a job different than a career?) Deanlwiley (talk) 18:44, 1 May 2010 (UTC)

I think the first few lines are very clear: "A derivative, in layman's terms, is an agreement or contract that is not based on a real, or true, exchange, i.e.: There is nothing tangible like money, or a product, that is being exchanged. For example, a person goes to the grocery store, exchanges a currency (money) for a commodity (say, an apple). The exchange is complete, both parties have something tangible. If the purchaser had called the store and asked for the apple to be held for one hour while the purchaser drives to the store, and the seller agrees, then a derivative has been created. The agreement (derivative) is derived from a proposed exchange (trade money for apple in one hour, not now)." I see there's going to be some changes made. I don't think this part should be removed, because it clarified the subject for me.--CoincidentalBystander (talk) 17:02, 16 May 2010 (UTC)

derivative means, there is no physical delivery

examples, weather, paying when a third party defaults .... non-examples, futures, call/put options CorvetteZ51 (talk) 11:00, 7 June 2010 (UTC)

Futures and options involve physical delivery when the contract expires, and they are derivatives. ~Amatulić (talk) 16:59, 9 June 2010 (UTC)

how so?, in what way is paying for something in advance, a derivative —Preceding unsigned comment added by CorvetteZ51 (talk • contribs) 09:16, 10 June 2010 (UTC)

You can buy a bushel of wheat or a barrel of oil directly for cash, on the spot market. Or you can create a contract that represents a bushel of wheat or barrel of oil to be delivered in the future. The contract fluctuates in value based on the underlying commodity, and is tradeable in parallel with the underlying commodity. That's what makes the contract a derivative instrument. It is derived from the underlying commodity. ~Amatulić (talk) 18:33, 15 June 2010 (UTC)

"Leverage of an economy's debt" subsection

The subsection of the article titled "Leverage of an economy's debt" includes this unsupported sentence: "Derivatives massively leverage the debt in an economy, making it ever more difficult for the underlying real economy to service its debt obligations, thereby curtailing real economic activity, which can cause a recession or even depression," which is really the only statement of substance in the subsection. Unless someone can provide a credible source for that statement, I am going to remove the subsection. Bond Head (talk) 22:14, 8 August 2010 (UTC)

The opening sentence of the lead

I have rewritten it as "A derivative is a financial instrument (or, more simply, an agreement between two parties) that has a value based on the expected future price movements of the asset it is linked to—called the underlying—such as a share or a currency". This looks to be more logical that the repetitious and clumsy construction that was there before. If however as a layman I have misunderstood anything please correct. Thanks. Jprw (talk) 11:13, 23 October 2010 (UTC) Not sure why so complicated. The value of a derivative depends on several variables - the price (or, more generically, the value) of the underlying, its volatility, interest rates, etc. — Preceding unsigned comment added by Thobitz (talk • contribs) 20:25, 22 March 2011 (UTC)

The second paragraph of the lead

I have changed:

"Referring to derivatives as stand-alone assets would be a misconception, since a derivative is incapable of having value of its own. However, some more commonplace derivatives, such as swaps, futures, and options, (which have a theoretical face value that can be calculated using formulas, such as Black-Scholes), have been traded on markets before their expiration date as if they were assets".

to:

"A derivative is not a stand-alone asset, since it has no value of its own. However, more common types of derivatives have been traded on markets before their expiration date as if they were assets".

This seems to be a lot clearer. The Black-Scholes reference belongs later on in the article, in my view. Let's of course discuss if necessary. Jprw (talk) 11:56, 23 October 2010 (UTC)

"Benefits"

The "Benefits" section of this article needs attention. It lacks a citation, and Greenspan later refuted his stance against unfettered deregulation—of which one may find much documentation, including "The Warning" episode of "Frontline."[1] Eightfoldpath (talk) 02:30, 13 January 2011 (UTC)

References

Derivatives not an asset?

I do not understand this paragraph: "A derivative is not a stand-alone asset, since it has no value of its own. However, more common types of derivatives have been traded on markets before their expiration date as if they were assets." Any references to back this statement? The Merriam-Webster defines asset as "an item of value owned". Derivatives can certainly be assets in a portfolio. The obviously have a value (which - well - sometimes can be negative). And I do not deem the expiration date relevant here. Unless anybody can provide a definition of a "stand-alone asset", and why it is relevant here, I suggest to remove this paragraph. — Preceding unsigned comment added by Thobitz (talk • contribs) 23:29, 25 March 2011 (UTC)

That part was very misleading, so I removed it. As you pointed out, once something is being traded on a market, it most definitely is an asset under the common definition. There are, of course, various definitions of assets and people talk about "real asset" versus "financial asset" (although I've never heard of "stand-alone asset"). It's best to avoid this as it may lead people to believe that you can't price a derivative or that they aren't traded (both false of course). In its stead, I've put in a statement about how a derivative may have a market value and be traded. --DudeOnTheStreet (talk) 14:33, 19 April 2011 (UTC)

You have removed the clarification. And you replaced the definition taken from the Hull (the leading book on derivatives) by a self-written statement without quotable sources. I am really not sure this is a good idea. Thobitz (talk) 21:38, 13 May 2011 (UTC)

I'm not sure what "clarification" I removed. You put back the definition which includes all kinds of things. Under that definition, stock shares are derivatives and so are basically any financial instruments, as their value all depend on other "more basic" variables. I really doubt Hull intends his definition to be used out-of-context of his book as a stand-alone definition. He has the benefit of a whole book to clarify what a derivative is. We don't. --DudeOnTheStreet (talk) 22:14, 13 May 2011 (UTC)

Also, comparing your edits to mine, I think yours seem to have left the article somewhat in shambles. I'm speaking not only of the formatting but of the prose, which is now much sloppier. Your insistence on "correctness" is commendable, but I actually made some effort at readability and wish you would do so as well. --DudeOnTheStreet (talk) 22:20, 13 May 2011 (UTC)

Looking back on this article and seeing how Thobitz's drive-by careless editing has left the first paragraph mangled with an incoherent sentence...that's quite annoying. I'm going to fix it -- I'm also tempted to just revert back because s/he doesn't seem to have even contemplated why I modified the one paragraph under discussion. His/her edit perpetrates the misconception that the underlying must be an asset, which is why I replaced the careless wording from before with just "underlying" in the first place. --DudeOnTheStreet (talk) 00:46, 28 May 2011 (UTC)

Majority of Derivatives Contracts on Exchanges?

"The most common derivatives have a market value and are traded on exchanges." The first part of this statement does not make sense - a derivative is a financial instrument, and once anybody trades it, it by default has a market value. The second part is completely wrong. According to the BIS, the outstanding nominal of OTC derivatives is about 10 times higher than that of ETD (582 vs 68 trillion USD) http://www.bis.org/statistics/derstats.htm. —Preceding unsigned comment added by Thobitz (talk • contribs) 22:00, 13 May 2011 (UTC)

Actually, there is a quite important distinction between happening to find one party that desires to buy your derivative at a certain price versus a price which is established by constant trading in an efficient market. My intent with the quoted statement was to emphasize that there is an efficient market mechanism for some kinds of derivatives. As for your second point, I intended "common" to refer to types of derivatives (like vanilla options) and not by volume traded, but now I see that's misleading. --DudeOnTheStreet (talk) 22:35, 13 May 2011 (UTC)

help please

"A derivative is a financial instrument whose value depends on underlying variables..."

Could someone please give a simpler definition? I still do not understand how it works or really how value is assigned, thanks. — Preceding unsigned comment added by 76.120.39.39 (talk) 07:36, 8 July 2011 (UTC)

This is why I believe "A derivative is essentially a contract whose payoff depends on the behavior of a benchmark" is easier to understand. Here "benchmark" refers to anything that the two parties of the contract can track and agree upon. For example, we might agree that I will pay you $50 if the temperature during next year's Wimbledon reaches above 85 degrees Fahrenheit. Obviously this agreement would have some value to you, but just as clearly you would not pay me 50 or more. So the value of this derivative would be between 0 and 50. Figuring out "the right value" is a tricky process, and in many cases (like this one), there doesn't have to be one definite "right value" either. For certain kinds of derivatives (and possibly by making certain additional assumptions about the market and overall preferences) you might be able to find the mathematically correct price. --DudeOnTheStreet (talk) 08:14, 10 July 2011 (UTC)

These laughably futile attempts to define "derivative" simply and clearly are a consequence of its nature: a linguistic trick to obscure meaning. — Preceding unsigned comment added by 94.116.11.193 (talk) 16:15, 19 May 2012 (UTC)

Updates

It appears like much of the content for this page dates to 2010 and earlier. After reading the article, I think we could make some improvements. Specifically, I'd like to remove some of the poor sourcing and biases (at least from my perspective) and re-order some of the content.

My Suggested Layout:

• Begin with a full definition of derivatives and lay out the history of why they were developed and how they’ve evolved.
• Describe how businesses freely choose to enter derivatives contracts to manage risk. Provide examples of the types of risk that managers hedge responsibly with derivatives.
• Explain how businesses would employ either of the two basic categories: lock products (e.g. swaps) or option products (e.g. caps, swaptions) to hedge current and future risk. It would be useful to explain that we purchase options when we arrange our car or home insurance—hardly dangerous endeavors.
• Of the pictures and tables included, why is there no basic box-and-arrow description of the products? We should place them here, or at least link to pages devoted to specific derivative products.
• Describe that—because the market is over-the-counter—derivatives have the great advantage of being specifically customized to projected cash flows for both current and future/anticipated risks.
• Explain the basics of pricing and valuation and how these complications can lead to information asymmetry between market participants.
• Finally, present much of the information already included in the article regarding the dubious use of derivatives for speculation, estimate the (small) proportion of the market devoted to speculation, and compile all the dangers that can result.
• With this background, present the challenges regulators face when crafting financial reform: They must ensure that banks’ derivative transactions don’t incur “systemically significant” risk to the financial system without stifling the legitimate and necessary risk mitigation outcomes business achieve with derivatives.

Observations About Citations:

• Citing Hull and Whaley as academic experts is absolutely right. BIS, The New York Times, and the Financial Times are also fine sources.
• Is an Associate Professor at Seton Hall Law School the best source for making the following claim regarding the effectiveness of proposed financial reforms? “Financial reforms within the US since the financial crisis have served only to reinforce special protections for derivatives, including greater access to government guarantees, while minimizing disclosure to broader financial markets.” [emphasis added]. The professor's claim is dubious, and we should at least include other sources for a more balanced view on financial reform.
• Citing an IMDB website article regarding the movie “Inside Job” to make the following claim is as laughable as the claim is wrong and incomplete: “Economists and bankers claimed derivatives made markets safer. But instead, they made markets unstable.”

For a more balanced view…My former colleagues have spent the past several years helping to educate Congressional staffers engaged in legislating financial reform. They write nuanced and compelling articles on the subject here:

• There’s a Derivative in Your Cereal: http://www.theatlantic.com/business/archive/2010/07/theres-a-derivative-in-your-cereal/60582/
• Beware of the Mongoose: http://www.ft.com/intl/cms/s/0/99e016e6-7a1e-11df-9871-00144feabdc0.html#axzz2EIPiO3VY
• Will the ‘Cure’ for Systemic Risk Kill the Economy? What cancer research can teach us about how to reform the derivatives market: http://www.theatlantic.com/business/archive/2011/06/will-the-cure-for-systemic-risk-kill-the-economy/240600/

These articles are excellent because they provide a balanced view on the difficulty of regulating derivatives through the current financial reform process. The rule-making period of the CFTC has been extended many months as a result of the real difficulties surrounding the issue. Highlighting these difficulties is important for informing cynics who might not understand the nature of the debate. While we wouldn't want to source all three articles in the updated entrey, I'm open to suggestions on which is the "best" one to describe the challenges facing financial reform.

~~rickkj~~ — Preceding unsigned comment added by Rickkjellberg (talk • contribs) 18:04, 6 December 2012 (UTC)

I hadn't heard from anyone, so I went forward with making the edits and additions I suggested above. I tried to be diligent with providing summaries of each edit, so please let me know if I've gone in the wrong direction or if you have further suggestions for improvements. ~~rickkj~~ — Preceding unsigned comment added by Rickkjellberg (talk • contribs) 04:26, 16 December 2012 (UTC)

Simplifying

I'm trying to simplify the introduction to the derivatives page, without taking away any of the essence. Please let me know if there are ways of simplifying further or if I'm simplifying so far as to misrepresent.

(The reason for this was my niece starting to work in a derivatives environment as a secretary and asking me what derivatives were as she couldn't understand the Wikipedia page, I'm doing it for all the lazy uncles out there).

JASpencer (talk) 08:47, 19 June 2014 (UTC)

Lack of historical background

Only one 19th century mention in 'Futures' and the 1981 date in 'Swaps'. It is important to know the context in which derivatives were invented and introduced to the market: Why and When. Please, somebody should take care of this. JaviPrieto (talk) 10:57, 29 September 2015 (UTC)

"Financial derivatives trading companies" edit.

For the list of companies, I added links to the Wikipedia articles corresponding to each company for which such articles are extant, and external links to companies' websites for those which such articles are not. The exception is the UK company "Cu," of which I could find no information about whatsoever. Also, the entire section appeared in the article twice; now it appears only once at the end. That "Cu" company probably needs to be investigated further. — Preceding unsigned comment added by 24.158.83.99 (talk) 16:21, 14 December 2015 (UTC)

Lists like this are almost always limited to those for which articles exist per WP:CSC. The flag icons are contrary to guideline MOS:FLAGICON. The value of this list is marginal in consideration of WP:NOTDIR and would appear to be a magnet for unencyclopedic future listings. Propose that the section be removed. – Brianhe (talk) 17:49, 30 October 2016 (UTC)

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change is needed

The topic is highly abstruse, and difficult even for someone with investment or economics experience to fully grasp; going at all in-depth with it is therefore clearly beyond the needs of any "typical user" of a general encyclopedia such as Wikipedia.

Firstly, the long goal: At 88K this article is far too long, and should be substantially reduced, certainly below ~40K and maybe so far as 25K. Rationale: if a reader doesn't "get it" in a couple hundred words, then it makes no sense whatever to continue shoveling in the minutiae. If the rare reader DOES possess the ability to follow along, then they likely have a grasp of the topic already and therefore aren't turning to W'pedia for the basics. In any case, the dictum Wikipedia is not a manual, guidebook, textbook, or scientific journal is apt, and ought be actually applied.

More immediately, the fact remains that the intro does a terrible job of introducing the concept — even as someone who's worked with derivatives, the first hundred words of the article makes my head spin. My guess is that the writer is afraid to "dumb it down" too far and so instead leaps into the middle of it with both proverbial feet. For something like this, a Tinkertoy approach is clearly warranted; that is to say, a skeletal model of a building is certainly not "engineering" to any significant degree, BUT it's a great way to introduce core concepts of engineering. Again: W'pedia IS NOT a textbook and "a casual grasp of the core concepts" is the article's entire purpose. Suggested:

• create/find a thumbnail summary of the concept of derivatives, and make it the very first words of the article.
  • it should be no more than 100 words, and likely much less: a DuckDuckGo search (and most any SE) posts the first 34 words.
  • it should use no "w.t.f.?" words or concepts that cannot be immediately apprehended by any typical community-college sophomore — and, really, in order to properly fulfill Wikipedia's mission, it ought to be useable by any typical 15-year-old … and while that SHOULD be the eventual goal, it's a very high bar at the moment.
  • after that first crucial statement, some mention can be made of the history of derivatives and "why they are soooo groovy" and all that fanboy stuffing so long as it is kept BRIEF as in like 250 words or so and definitely NOT 1,000.
  • and all such content MUST be explicitly sourced.
• the very first words of the body proper can then expand somewhat upon the initial abstract, and begin the unpacking of the concept. This is a good place to lay out some of the common terms, but NOT to leap into trivia or deep theory or "details that will become VERY important when you're working for Vanguard." Again, 1,000 words is likely much too long.
  • at present, Basics leads off with a pretty good sentence, then lapses into terminology — halfway through the second graf's first sentence appears "conditioned stochastically" and we're downhill from there.
• by the end of Basics, the reader has been beaten up (yet not at all enlightened) with the OTC-vs.-ETD divide, and then dazzled by the historical footwork of mentioning Japanese trading of rice in the 1700s. While this sort of tactic is used by grad assistants to keep the freshmen awake, here it's gratuitous trivia that further avoids answering the question "what the heck is a derivative, anyway?" There is certainly plenty of lard that can be cut to reduce article size by 75%.
  • given the lack of a clear-and-concise definition, launching into stuff like Size of market makes clear that the editors have at that point already lost track of what they're supposed to be doing.
  • for instance, there's a subsection, Types >> Futures that pretty much regurgitates what's in Futures contract and seems happily ignorant that such an article exists.

That should at least be a good start.
Weeb Dingle (talk) 17:31, 8 September 2019 (UTC)

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Etymology

How would you define financial derivatives by utilizing etymology?

When was the term used for the very first time?

https://www.etymonline.com/word/derivative?utm_source=app Kartasto (talk) 07:23, 27 October 2023 (UTC)

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