What are derivatives, anyway?
Think of them as side bets: financial contracts in which two parties take opposite positions on how a price, a rate, an index, or a natural phenomenon such as the temperature in Chicago is going to change. The contract’s value is “derived” from the underlying asset. What are they good for? They transfer risk from people who don’t want to bear it to speculators who are willing to do so in return for the chance to make a profit. By shedding unwanted risks, companies can afford to invest more in their core businesses. That promotes economic growth. For example, a company that owes a variable rate of interest on a $1 million loan could limit its risk by entering into an interest-rate swap that transforms its obligation into a fixed rate. How big is the market? The International Swaps & Derivatives Assn. recently estimated the worldwide market at $105 trillion. The Office of the Comptroller of the Currency (OCC) says U.S. commercial banks held $56 trillion of derivatives at the end of last
