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Are Derivative Investments Necessary For All Investors?

2012 Jun 9

A derivative investment usually is defined as a security on investments. It could be stocks, currencies, index, bonds, commodities, etc. They are flexible financial instruments that are necessary for many investors. Aside from being useful in structuring investment portfolios, derivatives are also great tools for transferring investment risks and capturing market mispricing; they also allow investors to gain access to new investment opportunities. Among the many benefits of derivative investment, below are 4 of the main purposes of derivative investments and why it is necessary for all investors.


1. Discovery of prices. The prices in the market depend on the climate conditions, the current situation in politics, the supply and demand of basic commodities, among many factors. All these affect market prices and with derivative investment investors are able to see how volatile their markets could be or how much losses or gains will they get.


2. Risk management. This is often one of the most important benefits of derivative investments. With a derivatives market, investors can easily identify the actual level of risk in the market. This is usually associated with hedging and speculation, which are both useful tools for companies in managing their risks effectively.


3. Reduce market transaction costs. Since derivatives investments are like forms of insurance, it is cost-efficient. With derivatives, investors may avoid involuntary risks; they can also easily implement different marketing ideas on many markets at a low cost, avoiding clashes and compromises.


4. Improve market efficiency. For instance, investors can invest in risk-free bonds. Doing so, investors can be neutral and have the freedom to choose whether to sell richer assets or buy the cheaper ones until equilibrium in prices is reached.


Today, a knowledgeable investor can create more profits with derivatives usually from changes in interest rates globally, shifting rates in currency exchange, even in changes in supply and demand for all commodities all over the world. There are a lot of widely recognized benefits of derivative investments but along with these great benefits of derivatives comes general risks which may arise too and investors must also consider on investing on derivatives. 



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