We are coming to the end of the most popular questions I
have been sent recently. So next week we will be back to regular programming
about subjects I think may help you more clearly understand finance. This week’s
question is based on a finance term that they did not understand (feel free to
ask me questions about even the smallest and simplest concepts as I often find
they can open up into very interesting topics to explore. Email me at illuminatingfinance@gmail.com).
“I heard someone say ‘floating security over assets’ and had no idea
what they were talking about. Could you please explain what this means?”
So the phrase ‘floating security over assets’ does sound
quite intimidating, and if you were on your own I wouldn’t blame you for just
saying ‘oh forget it’, and moving on with your life. Luckily you have me!
Together this week we will explore what this phrase is actually referring to.
So what the phrase is referring to are derivatives.
Derivatives are financial instruments whose values depend on (or derives from)
the values of another underlying variable, as if they are 'floating' over the asset. Very often the variables underlying
derivatives are the prices of traded assets. A stock option, for example, is a
derivative whose value is dependent on the price of a stock. However,
derivatives can be dependent on almost any variable from the weather to the
quality of harvest of a crop.
In recent years derivatives have become increasingly more
important and popular in finance. Futures and options are actively traded on
many stock exchanges and many financiers enter into forward contacts, swaps,
options, and other numerous other derivatives. Primarily derivatives are used
to transfer risk from one entity to another, but realistically they can be used
for hedging, speculation, or arbitrage.
As usual this is just scraping the surface when it comes to
derivatives. Contact me at illuminatingfinance@gmail.com
if you would like me to go into more detail. I am sure I will cover this topic
in time as this is a very complex and often misunderstood subject.
