Why are derivatives useful?
The key motivation for such instruments is that they are useful in reallocating risk either across time or among individuals with different risk-bearing preferences. One kind of passing-on of risk is mutual insurance between two parties who face the opposite kind of risk. For example, in the context of currency fluctuations, exporters face losses if the rupee appreciates and importers face losses if the rupee depreciates. By forward contracting in the dollar-rupee forward market, they supply insurance to each other and reduce risk. This sort of thing also takes place in speculative position taking, the person who thinks the price will go up is long a futures and the person who thinks the price will go down is short the futures. Another style of functioning works by a risk-averse person buying insurance, and a risk-tolerant person selling insurance. An example of this may be found on the options market : an investor who tries to protect himself against a drop in the index buys put optio
