The Difference Between Traditional and Derivative Instruments

What are the differences between traditional and derivative instruments?

The difference between traditional and derivative instruments is that the derivatives are traded on forward markets where the traditional ones are not. Derivative instruments include stocks, bonds, commodities, and price indices. A derivative can be good and bad depending on the gain of the derivative.

Why do companies use derivative instruments?

Derivative instruments are used as a way for the company to protect themselves against any future changes in stock prices, foreign currencies, and interest rates. They are used to help smooth the fluctuations caused by various types of risks. They use them to ensure an acceptable financial result. For example, commodity prices could be volatile, depending on the weather, production, and economic conditions. So companies plan effectively by locking in specific future revenues or costs in order to run the business successfully.

Are derivatives a good instrument?

They can be good if they are used correctly. If it provides leverage and flexibility to hedge, it can be good. Good derivatives are instruments such as universal life insurance policies, variable annuities, and even mutual funds. They can serve as a risk reduction tool if a business owner enters into a transaction with another in order to decrease the impact of potential risks that can occur. They also let companies earn more profits because it lets the owner choose when to buy and sell that will benefit them the most. They also allow a company the freedom to buy assets at a low cost or sell them at higher prices.