Abstract

This chapter discusses about derivative securities. Derivative securities can be defined as a security that has some essential feature, typically the price, which is derived from some future event. This event is often, though not always, associated with a security or commodity delivery to take place at a future date. The term “derivative security” is usually restricted to only include cases where the contingent claim is unbundled and traded as a separate security. The approach to define derivative securities is not without conceptual difficulties. An essential feature of the free standing derivative securities is the action of setting a price today for transaction to take place at a date in the future. However this feature is also present in other types of financial securities. A bond, for example, sets a price today for a sequence of fixed cash flows that will be received in the near future. A forward contract involves settlement and delivery at maturity, whereas a bond involves settlement today with delivery in the form of payments at future maturity dates. Using this approach, an option contract is somewhat anomalous, requiring a payment today to acquire the right to make a settlement at a price that is set today.

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