Question

What are some derivative products? Illustrate their use as investment vehicles. What are convertible securities? What are the advantages and disadvantages of owning a convertible security?

Answer 1

Derivative products are those securities which are derived from a underlying security. The value of derivative security depends upon the underlying price of the security. E.g. Future is derived from spot market security. E.g. Say, the value of S&P 500 is 2500 and the value of future will be at little premium 2525 (Assume). At expiry the future price will coincide with spot price. The future's price will increase or decrease with the price variation of spot price.

Convertible securities are those securities which after a certain period converts into another type of security. E.g. Convertible bonds is one of the most common convertible securities. Convertible bond is a fixed income security up to a certain period after which it converts into equity type security.

You can choose convertible bond if you feel equity return will too risky for a certain period of time and to avoid that you can buy convertible bond which will ensure your future ownership in the company as well as present interest income.