Financial Management: Principles and Applications, 13/e

20.4 Managing Risk with Exchange-Traded Financial Derivatives

A derivative contract is a security whose value is derived from the value of another asset or security (which is referred to as the underlying asset). Forward contracts that were discussed in the previous section are derivative contracts because the value of the forward contract is derived from the value of the underlying asset (e.g., a barrel of oil or one unit of a country’s currency). In this section, we consider derivative contracts that are traded in the securities markets. Unlike forward contracts, which can be customized to meet the specific asset risk and maturity requirements of the hedging firm, financial derivatives traded on organized exchanges are available only for specific ...