Bonds and derivatives

[monamimate]

What exactly are bonds and derivatives? How do they differ, what advantages and disadvantages do they have to the (private) investor? Thanks.

[ewand]

Bonds are a certificate which is evidence of a debt on which the issuer promises to pay the holder a specified amount of interest for a specified length of time, and to repay the loan on its maturity. Strictly speaking, assets are pledged as security for the loan, except in the case of government bonds, but the term is often loosely used to describe any debt issue. Bonds are issued by corporations and by federal, provincial and municipal governments. Bond holders are first in line before shareholders to claim any of a company's assets in the event of liquidation.

Derivatives are financial instruments which can be traded (e.g. options, warrants, rights, futures contracts, options on futures, etc.) on various markets. They are called derivatives because they are "derived" from some real, underlying item of value (such as a company share or other real, tangible commodity). A derivative is a tradeable "contract", created by exchanges and dealers. A warrant or option is the simplest form of derivative. The most common useage relates to the trading of commodity futures and options on futures - where pre-defined contracts relating to a right to buy or sell and underlying commodity or security are traded as opposed to the actual commodity or security itself. They are risky because they are time-fused and can expire worthless. Yet, the rewards are enormous and they are used primarily as HEDGING instruments.