Guide to Analysing Companies

Derivatives
A general term for financial assets that are “derived” from
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DERIVATIVES
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other financial assets. For example, an option to buy a Trea-
sury bond: the option (one financial asset) is derived from the
bond (another financial asset). The value of the option depends
on the performance of the bond. This can be taken a stage
further. For example, the value of an option on a futures
contract depends on the performance of the futures con-
tract, which, in turn, will vary with the value of the underlying
contract or security. Derivatives exist for assets (like equi-
ties or bonds) as well as for interest rates, currency exchange
rates and stockmarket indices. The main advantage of
derivatives is that they give investors leverage in the market in
which they are trading. This can either enhance their returns
or help to hedge risks.
Regulators worry that the market for derivatives undermines
the market for the original underlying asset. This happened in
late 1987, when so-called program traders (those using
computers to determine when and how to profit from arbi-
trage) were widely believed to have contributed to the
volatility of the market and the steep fall in share prices on
black monday. Regulators can reduce the risk of this hap-
pening by encouraging markets to become as liquid as possible.
Unlike the futures contracts for agricultural products on which
they are based, the supply of financial derivatives is virtually
unlimited. So it would be difficult, if not impossible, to corner
the market in, say, options on dollar/yen interest-rate contracts.
Financial weapons of mass destruction.
Warren Buffett on derivatives
Devaluation
A sudden, downward jerk in the value of a currency vis-a-vis
other currencies; the opposite of revaluation. Governments
devalue a country’s currency when its costs have risen faster
than those of its competitors, or when its exports are no longer
competitive in price. Devaluations are often exacerbated by the
activity of speculators in the foreign-exchange markets.
They buy and sell currencies in anticipation of, and to profit