agreed-upon benchmark. Derivatives can be issued based on currencies, commodi- ties, government or corporate debt, home mortgages, stocks, interest rates, or any combination. Company stock options, for instance, allow employ- ees and executives to profit from changes in a companys stock price without actually owning shares. Without knowing it, homeowners frequently use a type of pri- vately traded "forward" contract when they apply for a mortgage and lock in a borrowing rate for their house closing, typically for as many as 60 days in the future. Q: What are the most common forms of deriva- tives? A: Derivatives come in two basic categories, option- type contracts and forward-type contracts. These may be exchange-listed, such as futures and stock options, or they may be privately traded. Options give buyers the right, but not the obligation, to buy or sell an asset at a preset price over a specific pe- riod. The options price is usually a small percentage of the underlying assets value. Forward-type contracts, which include forwards, fu- tures and swaps, commit the buyer and the seller to trade a given asset at a set price on a future date. These are "price fixing" agreements that saddle the buyer with the same price risks as actually owning the asset. But normally, no money changes hands until the delivery date, when the contract is often settled in cash rather than by exchanging the asset. Q: In business, what are they used for? A: While derivatives can be powerful speculative in- struments, businesses most often use them to hedge. For instance, companies often use forwards and exchange- listed futures to protect against fluctuations in currency or commodity prices, thereby helping to manage import and raw-materials costs. Options can serve a similar purpose; interest-rate options such as caps and floors help companies control financing costs in much the same way that caps on adjustable-rate mortgages do for homeowners. Q: How do over-the-counter derivatives generally originate? A: A derivatives dealer, generally a bank or securities firm, enters into a private contract with a corporation, investor or another dealer. The contract commits the dealer to provide a return linked to a desired interest rate, currency or other asset. For example, in an interest- rate swap, the dealer might receive a floating rate in re- turn for paying a fixed rate. Q: Why are derivatives potentially dangerous? A: Because these contracts expose the two parties to market moves with little or no money actually changing hands, they involve leverage. And that leverage may be vastly increased by the terms of a particular contract. In the derivatives that hurt P&G, for instance, a given move in U.S. or German interest rates was multiplied 10 times or more. When things go well, that leverage provides a big re- turn, compared with the amount of capital at risk. But it also causes equally big losses when markets move the wrong way. Even companies that use derivatives to hedge, rather than speculate, may be at risk, since their operation would rarely produce perfectly offsetting gains. Q: If they are so dangerous, why are so many busi- nesses using derivatives? A: They are among the cheapest and most readily available means at companies disposal to buffer them- selves against shocks in currency values, commodity prices and interest rates. Donald Nicoliasen, a Price Wa- terhouse expert on derivatives, says derivatives "are a new tool in everybodys bag to better manage business returns and risks."   Source: Lee Berton, "Understanding the Complex World of Derivatives," The