Derivatives

derivatives

In finance, contracts whose value is derived from another asset, which can include stocks, bonds, currencies, interest rates, commodities, and related indexes. Purchasers of derivatives are essentially wagering on the future performance of that asset. Derivatives include such widely accepted products as futures and options. Concern over the risky nature of derivatives grew after some well-publicized corporate losses in 1994 involving Procter & Gamble, Metallgesellschaft AG of Germany, and Orange County, Calif. Anxiety intensified after the collapse in 1995 of the London-based merchant bank Barings PLC (now part of the Dutch ING Group NV). Securities regulators from 16 countries then agreed on measures to improve control of derivatives.

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Securities that derive their value from other financial instruments that are used by the insurance company to hedge its bets on which direction the market is moving. For example, cattle futures are a simple derivative in that the cattle futures contract increases or decreases in value as future prices change for cows on the hoof. When insurance companies use derivatives, they are more likely to use them in association with currency and interest rate transactions as a means of protecting themselves against adverse moves in interest rates or foreign currency exchanges. This instrument provides a mechanism for hedging against the interest rate risks that are inherent within insurance products by pricing in that risk in advance and protecting against future negative occurrences.

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		Britannica Concise Encyclopedia. Britannica Concise Encyclopedia. © 1994-2012 Encyclopædia Britannica, Inc. All rights reserved. Read more
		Barron's Insurance Dictionary. Dictionary of Insurance Terms. Copyright © 2008 by Barron's Educational Series, Inc. All rights reserved. Read more