Question

Discuss and provide examples of at least four derivative securities. Be sure to include the pros and cons of each one.

Answer 1

A derivative security is a financial security. The value of this security rely on the worth of a group of assets. There are many types of derivative securities, some of them are as follows:

1. Options: It is one of the type of derivative securities. It is a contract between the parties who want to purchase or sell their securities.

The main advantage of options is that it require low capital. Its disadvantage is that it requires high commissions and lacks in terms of liquidity.

2. Swaps: It is a sort of agreement between the parties to exchange certain financial instruments.

The main advantage of swaps is that it is cheaper as compared to other securities. Swaps generally have longer term than options and futures etc. Its main drawback is lack of liquidity.

3. Futures: It is one of the type of derivative securities. It is a contract between the parties who want to purchase or sell their securities at specified prices and at some specified future date.

The main advantage of futures is the low margins, they have. The disadvantage is non-flexibility for accounting purposes.

4. Forwards: These are bilateral contracts where the parties who want to purchase or sell their securities at specified prices decided today.

The main advantage is that these are over-the-counter products and provides price protection. There main disadvantage is that these contracts are difficult to cancel.