Derivatives Risk Law and Legal Definition
A “derivative” is a contract whose value is based on, or derived from, the value or performance of another investment. Examples of derivatives include options, futures, swaps and forward contracts. Derivatives require or allow the holder to purchase or sell assets such as stocks, currencies or commodities at a certain price now or in the future. Derivatives have certain risks. The following are some of the most common ones:
1. Derivatives may not prevent changes in the market value of the mutual fund’s investments or prevent losses if the market value of the investments falls.
2. A mutual fund may not be able to purchase or sell a derivative to make a profit or limit a loss.
3. Derivatives can limit a mutual fund’s ability to benefit from increases in the stock markets.
4. There is no guarantee that the counterparty in a derivative will meet its obligations.
5. If the counterparty in a derivative, or a third party holding assets of the mutual fund in connection with a derivative, goes bankrupt, the mutual fund could lose any collateral it deposited and any gains made on the derivative.
6. Some derivatives traded on foreign markets may be harder to trade and have higher credit risk than derivatives traded in North America.