Description
Assignment 2
This Assignment is being assessed by the following Course Outcome:
Investigate derivatives and derivative financial statements.
Write a 2-page paper in which you explain and analyze the different types of derivatives and how they affect financial statements. You are required to use at least two journal articles and follow proper APA format.
Unformatted Attachment Preview
Purchase answer to see full attachment
Explanation & Answer
Attached.
Running head: IMPACT OF DERIVATIVES ON FINANCIAL STATEMENTS
Impact of Derivatives on Financial Statements
Student’s Name:
Institutional Affiliation:
1
IMPACT OF DERIVATIVES ON FINANCIAL STATEMENTS
2
Impact of Derivatives on Financial Statements
Derivatives refer to tools that gauge the financial security of a transaction or an
organization using its assets. The derivative, which acts as an agreement between two or more
parties, acquires its price from asset variations. Some of these assets include stocks, market
indexes, currencies, bonds, interest rates, and commodities, which are traded through brokerages.
There are four types of derivatives, namely, forwards, futures, options, and swaps.
A forward contract refers to a private agreement between two parties to sell a specific
asset or commodity over the counter at a later time. The price of the item is decided at the time
of the agreement. It is the oldest form of derivatives yet the simplest of those that are available
today. There are two types of participants in forward contracts, that is, hedgers and speculators.
Hedgers seek to steady the costs or revenues of their business activities rather than seeking profit
(Rogers, 2019). A corresponding market gain or loss for the asset offsets the hedger's gains or
losses to some extent. On the other hand, speculators focus on predicting the direction of the
prices of the assets. They are not interested in purchasing the underlying assets. Forward
contracts tend to have fewer speculators compared to hedgers.
Compared to the participants in future contracts, hedgers and speculators bear more credit
risks as they do not engage a clearinghouse, which would otherwise guarantee the performance
(Ramlall & Ramlall, 2018). A party in a forward contract has a higher likelihood of default, and
the affected party may choose to sue them. Therefore, forward contracts tend to be more
expensive as they incorporate premiums for credit risks.
On the other hand, a futures contract or futures refers to a legal agreement to trade
underlying assets and receive it on the expiration of the futures contract. Conversely, the seller
IMPACT OF DERIVATIVES ON FINANCIAL STATEMENTS
3
agrees to provide and deliver the asset at the agreed price, regardless of the market price at the
time of expiry. The buyer and the seller do not agree with each other but rather with the
exchange.
Future contracts are valid as they allow an investor to predict the direction of a financial
instrument, a security or a commodity, whether long or short, through the use of leverage.
Additionally, they can be used to hedge price movements of the underlying assets to assist in the
prevention of losses in case the price adjustments are unfavorable (Bartram, 2019). F...
Review
Review
