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What are Fund Derivatives?

Danielle DeLee
Danielle DeLee

Fund derivatives are instruments that allow investors to link the returns of their portfolios to the performance of funds without actually investing in those funds. The value of these derivatives depends on the value of the shares of the fund on which they are based. Using them, investors can combine derivatives with shares of the underlying fund to create portfolios based on derivatives investment strategies.

A fund is an entity that invests on behalf of people and institutions that contribute money to it by purchasing shares. The money from the purchase of all of the shares is combined, and the fund manager decides how to invest it. The returns on the fund portfolio translate into a higher share price, which transfers the return to the investors.

Businessman with a briefcase
Businessman with a briefcase

The fund setup is often more profitable for investors than individual investors for two reasons. First, the fund has more money than each individual, so it can invest in more markets than they can; this is because some markets have minimum purchase requirements. Second, investing in a fund puts money in the hands of a manager, who has investing experience. Individual investors may not know as much about investing, or they may not have the same amount of time to devote to managing investments that professionals have.

Fund derivatives are defined as a category by their underlying assets, which must be managed funds. They can, however, have a variety of types of funds as underlying assets. They could be, for example, hedge funds or private equity funds. Mutual funds are also common underlying assets for fund derivatives.

There are several different types of fund derivatives, which are similar to the varieties of other kinds of derivatives. For example, fund derivatives can be call options, which allow the holder to buy shares of the fund at a specified price at a specified date. Fund derivatives could also be put options, which give the holder the option to sell, or forwards, in which one party promises to sell a certain amount of shares of the fund at an agreed-upon price.

Investors might choose to invest in fund derivatives for several reasons. Some might buy them to add a fund component to their portfolios in order to diversify. In some cases, investors might have shares in the fund already, but they purchase derivatives to decrease the risk of the fluctuation in the price of their shares. While holding derivatives protects investors from large losses, it can also limit the maximum profits that their portfolios can realize.

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