Question

what is a financial statement derivative.

Identify an example and how company’s use to leverage the business activities.

Answer 1

Answer :- A financial statement derivative is a bilateral contract or payment exchange agreement whose value depends on - derives from - the value of an underlying asset, reference rate or index. Every financial statement derivative transaction is constructed from two simple building blocks that are fundamental to all derivatives :- Forwards and options.

(a) Forward-based derivatives :- There are three divisions of forward-based derivatives :- i). Forward contract. (ii). Swaps and (iii) Future contracts.

  (b). Options :- They offer, in exchange for a premium, the right - but not the obligation - to buy (call option) or sell (put option) the underlying at the excercise price (strike price) during a period or on a specific date.

Financial statement derivatives are typically used by large investors to manage the risk. There are two key concepts about the financial statement derivatives : -

A).They help create leverage, so that an object can be related in terms of other values and you can minimize the risk level.

B). They are used to either take on more risk or reduce risk, depending on what kind of contractual agreement is made.

Financial statement derivatives provide leverage because of small movements in underlying value can cause large movement in the value of the derivatives.