Author Question: What are derivatives and derivative markets? Explain with an ... (Read 136 times)

sc00by25 · **on:** Jun 30, 2018

What are derivatives and derivative markets? Explain with an example.

Question 2

The greater the differentiation among the products of monopolistically competitive firms, the lesser is the price-elasticity of demand.
a. True
b. False
Indicate whether the statement is true or false

cegalasso · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

Derivatives are financial instruments whose value is derived from an underlying asset. People might enter into forward contracts that fix the price today for delivery of a good at some date in the future. The buyer of the forward contract is longcommitted to take deliveryand the seller is shortcommitted to deliver it. There is no requirement that the seller actually own the commodity or that the buyer have the necessary cash to pay for it when they make the original agreement. The value of future delivery in a forward contract depends on the market price of the commodity. (The commodity is usually called the underlying.) Because its value depends on the price of the underlying, the forward contract is an example of a derivative or a derivative asset. A futures contract is a standardized forward contract, traded on a futures exchange. Like a forward contract, it sets a price today for future delivery.

As an example, the New York Mercantile Exchange (NYMEX) contract in natural gas specifies its product not by volume but by its heat content. A contract is for 10 thousand million British thermal units (or 10,000 mmbtu, roughly 10 million cubic feet) of gas, to be delivered at the Henry Hub, a pipeline junction in southern Louisiana. It is to flow at as uniform a rate as possible over the month specified in the contract. Contracts are possible for deliveries in every month over the next six years. The contract is valuable to both producers and large consumers of gas as a hedge that lessens the risks associated with the highly unstable (volatile) spot price. The prime use of the gas contract is as a hedge, and fewer than three percent of such contracts go to delivery in most months. The remainder are settled in cash through the exchange, which acts as a counterparty for buyers and sellers to eliminate the risk of nonperformance.

Answer to Question 2

True