DERIVATIVES

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Derivative
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Derivative
http://www.investopedia.com/terms/d/derivative.asp
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In finance, a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.  

Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Because derivatives are just contracts, just about anything can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.

Derivatives are generally used to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using American dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into euros. 


Derivatives Time Bomb
http://www.investopedia.com/terms/d/derivativestimebomb.asp
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A possibile situation where the financial markets plunge into chaos if the massive derivatives positions owned by hedge funds and the large banks were to move against those parties.

Institutional investors have increasingly used derivatives to either hedge their existing positions, or to speculate on given markets or commodities. The growing popularity of these instruments is both good and bad because although derivatives can be used to mitigate portfolio risk. Institutions that are highly leveraged can suffer huge losses if their positions move against them. 

A number of well-known hedge funds have imploded in recent years as their derivative positions declined dramatically in value, forcing them to sell their securities at markedly lower prices to meet margin calls and customer redemptions. One of the largest hedge funds to collapse in recent years as a result of adverse movements in its derivatives positions was Long Term Capital Management (LTCM).

Investors use the leverage afforded by derivatives as a means of increasing their investment returns. When used properly, this goal is met. However, when leverage becomes too large, or when the underlying securities decline substantially in value, the loss to the derivative holder is amplified. The term "derivatives time bomb" relates to the speculation that the large number of derivatives positions and increasing leverage taken on by hedge funds and investment banks could lead to an industry-wide meltdown.


International Securities Exchange (ISE)
http://www.investopedia.com/terms/i/internationalsecurityexchange.asp
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An electronic options exchange that was launched in 2000. The exchange provides investors with greater liquidity and the ability to execute transactions at a much faster rate than the open-cry trading floor that has historically been the basis for options trading. In addition to being an options exchange, the ISE is also a publicly traded company. 

The advent of the electronic options exchange was considered revolutionary. Computerized trading has proved extremely efficient, and has added to the liquidity in the options markets. This added liquidity has helped to reduce pricing volatility. Prior to electronic trading, investors looking to purchase or sell options relied solely on floor brokers to execute their trades.   


Exchange

http://www.investopedia.com/terms/e/exchange.asp
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A marketplace in which securities, commodities, derivatives and other financial instruments are traded. The core function of an exchange - such as a stock exchange - is to ensure fair and orderly trading, as well as efficient dissemination of price information for any securities trading on that exchange. Exchanges give companies, governments and other groups a platform to sell securities to the investing public.

An exchange may be a physical location where traders meet to conduct business or an electronic platform.

May also be referred to as "share exchange" or "bourse" depending on geographical location.   

Exchanges are located all around the globe, with some of the more famous ones being the New York Stock Exchange, Nasdaq and the Tokyo Stock Exchange. More and more trading is being done on electronic exchanges as markets become more advanced and as the exchanges themselves are able to ensure fair trading without requiring all members to be on the same trading floor.  

Each exchange will have certain listing requirements for any company or group that wishes to offer securities for trading. Some exchanges are more rigid than others, but basic requirements for stock exchanges include regular financial reports and audited earnings reports.  


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