You might have heard about futures, CFDs, options, or forward contracts. But have you ever wondered how all of these were created?
Financial derivatives – what’s this all about?
Financial derivatives refer to those contracts that base their value on an underlying asset. That's why derivatives don't have a value of their own; they depend on the asset they are linked to.
Traders and investors use financial derivatives for different purposes, like hedging investments to reduce risks or making the most out of price fluctuations in various markets through CFDs or other popular solutions.
Start trading CFDs with CAPEX.com! Create an account here.
Before you get any further, check out our F.X. derivatives’ short introduction article here. It can serve you well because it will help you understand crucial terminologies such as options, forward, swaps or spot.
Derivative contracts have been around for many years. In ancient times, they were supposedly used to keep the balance for the exchange of goods and services. Throughout the centuries, their purposes gradually changed, as we will see in the next chapter of our story.
A journey to the past – from Babylon to the United States
Once upon a time in a land far, far away…
The very first notion remotely resembling what we know as derivatives nowadays was mentioned more than 4.000 years ago in ancient Babylon. According to various sources, merchants from Babylon were getting loans from creditors to supply their caravans. The delivery's rate of success influenced the repayment value, so risks were distributed between parties. Simultaneously, the interest was much higher than the ordinary loan to cover losses if the cargo is lost.
The journey continues in Europe.
Fast-forward some three more millennia, and we switch continents, landing in 12-th century Europe. The economic boom led to an incredible surge in trade development, so the trade law was created - “Lettre de faire.” Essentially, it was somehow resembling what we know today as a forward contract for the goods delivery settled upon at a specific time in the future.
The following developments surrounding the old concept of derivatives happened in quick succession in the seventeenth century. In the 17th century, options for tulip bulbs were starting to be traded in the Netherlands. By the Mid-1630s, the first forward contracts made their appearance in the U.K. - the Royal Exchange in England.
And then spreads to the Far East…
Financial derivatives also found their way to Japan. In Mid 16th century, history records that Japanese landlords were paid rent in the rice harvest. The rent value primarily relied on weather conditions, so landlords started to use warehouses to keep rice and used rice coupons. Whoever owned these coupons received a specific amount of rice at a specified date for a predetermined cost.