Derivatives: The Insurance of the Financial World

Paper Summary:

This paper looks at how a derivative is defined as a financial instrument, such as an option or future, that derives its value from the movement of a price, exchange rate, or interest rate associated with some other item. It provides different examples of how derivatives are used in the financial world and examines how they have been blamed for many financial scandals, such as the fall of Enron, WorldCom, and Global Crossing.

Outline
Introduction
Types of Derivatives
Examples of Derivatives
Accounting for Derivatives
Derivatives and Scandals
Conclusion

From the Paper:

"Derivatives are classified into two different types. There are linear derivatives; whose payoff represents a linear function, meaning with every movement, a dollar amount is directly affected. The other form of derivative is a non-linear derivative, in which the payoff changes with time and location (Sooran, 2004). When an individual purchases shares of a company, the payoff is linear, not accounting for dividends paid. If the stock purchased increases, a profit is earned. In contrast, if the stock purchased decreases, a loss is incurred. An investor can choose options to minimize their risk when investing."

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