Explanation:
The value of derivatives is derived from a large universe of underlying variables. These underlying variables are not limited to financial, capital, or physical assets (commodities), but they can also include inflation, growth rates, natural disasters, election results, rainfalls, etc.
Option A is incorrect. Derivatives trade on regulated exchanges and unregulated (OTC) markets only.
Option B is incorrect. The value of the derivative is not equal to the value of its underlying, but the value of the derivative is derived from the value of its underlying.
Option D is incorrect. Derivatives are not only used for hedging risk and speculation but are also used for earning arbitrage profits.
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Q.4 James Fernandez, a former derivatives trader, is currently authoring/writing an introductory book on derivatives strategies. His book aims to cater to the beginning derivatives traders market. Following is the excerpt from the first chapter of his book: “Derivatives are financial instruments that trade on regulated markets only and whose value is derived from the value of underlying financial assets and commodities. These underlying assets are commodities such as oil, copper (physical assets), or financial assets like bonds or stocks. These derivatives are used for hedging, speculation, and arbitrage.” Why is James' definition of derivatives incorrect?
A
Derivatives do not trade on regulated markets, but they trade on unregulated markets instead.
B
The value of a specific derivative is equal to the value of its underlying asset.
C
The underlying variables of derivatives do not only include financial assets and commodities but also include any variables ranging from interest rates to the amount of rainfall in a specific area.
D
Derivatives are only used for hedging and speculation.
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