What are derivatives and how do they relate to risk management?

What are derivatives and how do they relate to risk management?

Derivatives are financial instruments whose value is derived from an underlying asset. They are used in risk management to hedge against price fluctuations.

Can you give me an example of a derivative?

Sure! A common example of a derivative is a futures contract, which obligates the buyer to purchase an asset at a predetermined price at a future date.

How do companies use derivatives for risk management?

Companies use derivatives to hedge against risks such as currency fluctuations, interest rate changes, and commodity price volatility, ensuring more stable financial performance.

What are the risks associated with using derivatives?

While derivatives can mitigate risk, they also carry risks like market risk, credit risk, and liquidity risk, which can lead to significant losses if not managed properly.