What are the main distinctions between a traditional financial instrument and a derivative financial instrument?
Three basic characteristics of derivative financial instruments distinguish derivatives from traditional financial instruments: (i) The instrument has one or more underlyings and an identified payment provision; (ii) The instrument requires little or no investment at the inception of the contract; (iii) The instrument requires or permits net settlement. Trading securities: Example – A bond that will mature in 4 years was bought 1 month ago when the price dropped. As soon as the value increases, which is expected next month, it will be sold. Held-to-maturity securities: Example – 10% of the outstanding stock of Farm-Co was purchased. The company is planning on eventually getting a total of 30% of its outstanding stock. Example – Preferred stock was purchased for its constant dividend. The company is planning to hold the preferred stock for a long time. Example – A bond that matures in 10 years was purchased. The company is investing money set aside for an expansion project planned 10 ye
