From a yahoo FAQ page:
“At Investorwords.com, we learned that when you invest in a derivative, the underlying asset is usually a commodity, bond, stock, or currency. You “bet” that the value derived from the underlying asset will increase or decrease by a certain amount within a certain fixed period of time.”
Seems like derivatives are too big a share of the financial markets? So what happens to prevent more problems?
Certain derivatives serve a very useful purpose as hedges. Many, many companies use hedging strategies to offset wild swings in input costs. for example, FedEx and UPS use fuel hedges to partially offset the increase in the cost of fuel. Companies use FX hedges all the time to stabilize international operations costs. In concept, the Credit Default Swaps were used to offset the risk posed by questionable loans. Unfortunately the leverage ration got way out of whack. I am not an expert on derivatives by any means but common sense would tell me that the leverage ratios allowed should be within certain limits so as to mitigate the potential risk should the underlying assets lose too much value. That can be managed by FASB and GAAP.