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Derivative (finance)

In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the underlying. Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation, or getting access to otherwise hard-to-trade assets or markets.

Some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps. Most derivatives are traded over-the-counter (off-exchange) or on an exchange such as the Chicago Mercantile Exchange, while most insurance contracts have developed into a separate industry. In the United States, after the financial crisis of 2007–2009, there has been increased pressure to move derivatives to trade on exchanges.

Derivatives are one of the three main categories of financial instruments, the other two being equity (i.e., stocks or shares) and debt (i.e., bonds and mortgages). The oldest example of a derivative in history, attested to by Aristotle, is thought to be a contract transaction of olives, entered into by ancient Greek philosopher Thales, who made a profit in the exchange. However, Aristotle did not define this arrangement as a derivative but as a monopoly (Aristotle's Politics, Book I, Chapter XI). Bucket shops, outlawed in 1936 in the US, are a more recent historical example.

Basics
Derivatives are contracts between two parties that specify conditions (especially the dates, resulting values and definitions of the underlying variables, the parties' contractual obligations, and the notional amount) under which payments are to be made between the parties. The assets include commodities, stocks, bonds, interest rates and currencies, but they can also be other derivatives, which adds another layer of complexity to proper valuation. The components of a firm's capital structure, e.g., bonds and stock, can also be considered derivatives, more precisely options, with the underlying being the firm's assets, but this is unusual outside of technical contexts.

From the economic point of view, financial derivatives are cash flows that are conditioned stochastically and discounted to present value. The market risk inherent in the underlying asset is attached to the financial derivative through contractual agreements and hence can be traded separately. The underlying asset does not have to be acquired. Derivatives therefore allow the breakup of ownership and participation in the market value of an asset. This also provides a considerable amount of freedom regarding the contract design. That contractual freedom allows derivative designers to modify the participation in the performance of the underlying asset almost arbitrarily. Thus, the participation in the market value of the underlying can be effectively weaker, stronger (leverage effect), or implemented as inverse. Hence, specifically the market price risk of the underlying asset can be controlled in almost every situation.

There are two groups of derivative contracts: the privately traded over-the-counter (OTC) derivatives such as swaps that do not go through an exchange or other intermediary, and exchange-traded derivatives (ETD) that are traded through specialized derivatives exchanges or other exchanges.

Derivatives are more common in the modern era, but their origins trace back several centuries. One of the oldest derivatives is rice futures, which have been traded on the Dojima Rice Exchange since the eighteenth century. Derivatives are broadly categorized by the relationship between the underlying asset and the derivative (such as forward, option, swap); the type of underlying asset (such as equity derivatives, foreign exchange derivatives, interest rate derivatives, commodity derivatives, or credit derivatives); the market in which they trade (such as exchange-traded or over-the-counter); and their pay-off profile.

Derivatives may broadly be categorized as "lock" or "option" products. Lock products (such as swaps, futures, or forwards) obligate the contractual parties to the terms over the life of the contract. Option products (such as interest rate swaps) provide the buyer the right, but not the obligation to enter the contract under the terms specified.

Derivatives can be used either for risk management (i.e. to "hedge" by providing offsetting compensation in case of an undesired event, a kind of "insurance") or for speculation (i.e. making a financial "bet"). This distinction is important because the former is a prudent aspect of operations and financial management for many firms across many industries; the latter offers managers and investors a risky opportunity to increase profit, which may not be properly disclosed to stakeholders.

Along with many other financial products and services, derivatives reform is an element of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. The Act delegated many rule-making details of regulatory oversight to the Commodity Futures Trading Commission (CFTC) and those details are not finalized nor fully implemented as of late 2012.

Size of market
To give an idea of the size of the derivative market, The Economist has reported that as of June 2011, the over-the-counter (OTC) derivatives market amounted to approximately $700 trillion, and the size of the market traded on exchanges totaled an additional $83 trillion. For the fourth quarter 2017 the European Securities Market Authority estimated the size of European derivatives market at a size of €660 trillion with 74 million outstanding contracts.

However, these are "notional" values, and some economists say that these aggregated values greatly exaggerate the market value and the true credit risk faced by the parties involved. For example, in 2010, while the aggregate of OTC derivatives exceeded $600 trillion, the value of the market was estimated to be much lower, at $21 trillion. The credit-risk equivalent of the derivative contracts was estimated at $3.3 trillion.

Still, even these scaled-down figures represent huge amounts of money. For perspective, the budget for total expenditure of the United States government during 2012 was $3.5 trillion, and the total current value of the U.S. stock market is an estimated $23 trillion. Meanwhile, the global annual Gross Domestic Product is about $65 trillion.

At least for one type of derivative, credit default swaps (CDS), for which the inherent risk is considered high, the higher, nominal value remains relevant. It was this type of derivative that investment magnate Warren Buffett referred to in his famous 2002 speech in which he warned against "financial weapons of mass destruction". CDS notional value in early 2012 amounted to $25.5 trillion, down from $55 trillion in 2008.

Usage
Derivatives are used for the following:
 * Hedge or to mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out
 * Create option ability where the value of the derivative is linked to a specific condition or event (e.g., the underlying reaching a specific price level)
 * Obtain exposure to the underlying where it is not possible to trade in the underlying (e.g., weather derivatives)
 * Provide leverage (or gearing), such that a small movement in the underlying value can cause a large difference in the value of the derivative
 * Speculate and make a profit if the value of the underlying asset moves the way they expect (e.g. moves in a given direction, stays in or out of a specified range, reaches a certain level)
 * Switch asset allocations between different asset classes without disturbing the underlying assets, as part of transition management
 * Avoid paying taxes. For example, an equity swap allows an investor to receive steady payments, e.g. based on SONIA rate, while avoiding paying capital gains tax and keeping the stock.
 * For arbitraging purpose, allowing a riskless profit by simultaneously entering into transactions into two or more markets.

Mechanics and valuation
Lock products are theoretically valued at zero at the time of execution and thus do not typically require an up-front exchange between the parties. Based upon movements in the underlying asset over time, however, the value of the contract will fluctuate, and the derivative may be either an asset (i.e., "in the money") or a liability (i.e., "out of the money") at different points throughout its life. Importantly, either party is therefore exposed to the credit quality of its counterparty and is interested in protecting itself in an event of default.

Option products have immediate value at the outset because they provide specified protection (intrinsic value) over a given time period (time value). One common form of option product familiar to many consumers is insurance for homes and automobiles. The insured would pay more for a policy with greater liability protections (intrinsic value) and one that extends for a year rather than six months (time value). Because of the immediate option value, the option purchaser typically pays an up front premium. Just like for lock products, movements in the underlying asset will cause the option's intrinsic value to change over time while its time value deteriorates steadily until the contract expires. An important difference between a lock product is that, after the initial exchange, the option purchaser has no further liability to its counterparty; upon maturity, the purchaser will execute the option if it has positive value (i.e., if it is "in the money") or expire at no cost (other than to the initial premium) (i.e., if the option is "out of the money").

Hedging
Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another. For example, a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future. Both parties have reduced a future risk: for the wheat farmer, the uncertainty of the price, and for the miller, the availability of wheat. However, there is still the risk that no wheat will be available because of events unspecified by the contract, such as the weather, or that one party will renege on the contract. Although a third party, called a clearing house, insures a futures contract, not all derivatives are insured against counter-party risk.

From another perspective, the farmer and the miller both reduce a risk and acquire a risk when they sign the futures contract: the farmer reduces the risk that the price of wheat will fall below the price specified in the contract and acquires the risk that the price of wheat will rise above the price specified in the contract (thereby losing additional income that he could have earned). The miller, on the other hand, acquires the risk that the price of wheat will fall below the price specified in the contract (thereby paying more in the future than he otherwise would have) and reduces the risk that the price of wheat will rise above the price specified in the contract. In this sense, one party is the insurer (risk taker) for one type of risk, and the counter-party is the insurer (risk taker) for another type of risk.

Hedging also occurs when an individual or institution buys an asset (such as a commodity, a bond that has coupon payments, a stock that pays dividends, and so on) and sells it using a futures contract. The individual or institution has access to the asset for a specified amount of time, and can then sell it in the future at a specified price according to the futures contract. Of course, this allows the individual or institution the benefit of holding the asset, while reducing the risk that the future selling price will deviate unexpectedly from the market's current assessment of the future value of the asset.

Derivatives trading of this kind may serve the financial interests of certain particular businesses. For example, a corporation borrows a large sum of money at a specific interest rate. The interest rate on the loan reprices every six months. The corporation is concerned that the rate of interest may be much higher in six months. The corporation could buy a forward rate agreement (FRA), which is a contract to pay a fixed rate of interest six months after purchases on a notional amount of money. If the interest rate after six months is above the contract rate, the seller will pay the difference to the corporation, or FRA buyer. If the rate is lower, the corporation will pay the difference to the seller. The purchase of the FRA serves to reduce the uncertainty concerning the rate increase and stabilize earnings.

Speculation
Derivatives can be used to acquire risk, rather than to hedge against risk. Thus, some individuals and institutions will enter into a derivative contract to speculate on the value of the underlying asset. Speculators look to buy an asset in the future at a low price according to a derivative contract when the future market price is high, or to sell an asset in the future at a high price according to a derivative contract when the future market price is less.

Speculative trading in derivatives gained a great deal of notoriety in 1995 when Nick Leeson, a trader at Barings Bank, made poor and unauthorized investments in futures contracts. Through a combination of poor judgment, lack of oversight by the bank's management and regulators, and unfortunate events like the Kobe earthquake, Leeson incurred a $1.3 billion loss that bankrupted the centuries-old institution.

Arbitrage
Individuals and institutions may also look for arbitrage opportunities, as when the current buying price of an asset falls below the price specified in a futures contract to sell the asset.

Proportion used for hedging and speculation
The true proportion of derivatives contracts used for hedging purposes is unknown, but it appears to be relatively small. Also, derivatives contracts account for only 3–6% of the median firms' total currency and interest rate exposure. Nonetheless, we know that many firms' derivatives activities have at least some speculative component for a variety of reasons.

Types
In broad terms, there are two groups of derivative contracts, which are distinguished by the way they are traded in the market:

Over-the-counter derivatives
Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps, forward rate agreements, exotic options – and other exotic derivatives – are almost always traded in this way. The OTC derivative market is the largest market for derivatives, and is largely unregulated with respect to disclosure of information between the parties, since the OTC market is made up of banks and other highly sophisticated parties, such as hedge funds. Reporting of OTC amounts is difficult because trades can occur in private, without activity being visible on any exchanges

According to the Bank for International Settlements, who first surveyed OTC derivatives in 1995, reported that the "gross market value, which represent the cost of replacing all open contracts at the prevailing market prices, ... increased by 74% since 2004, to $11 trillion at the end of June 2007 (BIS 2007:24)." Positions in the OTC derivatives market increased to $516 trillion at the end of June 2007, 135% higher than the level recorded in 2004. The total outstanding notional amount is US$708 trillion (as of June 2011). Of this total notional amount, 67% are interest rate contracts, 8% are credit default swaps (CDS), 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other. Because OTC derivatives are not traded on an exchange, there is no central counter-party. Therefore, they are subject to counterparty risk, like an ordinary contract, since each counter-party relies on the other to perform.

Exchange-traded derivatives
Exchange-traded derivatives (ETD) are those derivatives instruments that are traded via specialized derivatives exchanges or other exchanges. A derivatives exchange is a market where individuals trade standardized contracts that have been defined by the exchange. A derivatives exchange acts as an intermediary to all related transactions, and takes initial margin from both sides of the trade to act as a guarantee. The world's largest derivatives exchanges (by number of transactions) are the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of the 2007 merger of the Chicago Mercantile Exchange and the Chicago Board of Trade and the 2008 acquisition of the New York Mercantile Exchange). According to BIS, the combined turnover in the world's derivatives exchanges totaled US$344 trillion during Q4 2005. By December 2007 the Bank for International Settlements reported that "derivatives traded on exchanges surged 27% to a record $681 trillion."

Inverse ETFs and leveraged ETFs
Inverse exchange-traded funds (IETFs) and leveraged exchange-traded funds (LETFs) are two special types of exchange traded funds (ETFs) that are available to common traders and investors on major exchanges like the NYSE and Nasdaq. To maintain these products' net asset value, these funds' administrators must employ more sophisticated financial engineering methods than what's usually required for maintenance of traditional ETFs. These instruments must also be regularly rebalanced and re-indexed each day.

Common derivative contract
Some of the common variants of derivative contracts are as follows:
 * 1) Forwards: tailored contract between two parties, where payment takes place at a specific time in the future at today's pre-determined price.
 * 2) Futures: contracts to buy or sell an asset on a future date at a price specified today. A futures contract differs from a forward contract in that the futures contract is a standardized contract written by a clearing house that operates an exchange where the contract can be bought and sold; the forward contract is a non-standardized contract written by the parties themselves.
 * 3) Options: contracts that give the owner the right, but not the obligation, to buy (in the case of a call option) or sell (in the case of a put option) an asset. The price at which the sale takes place is known as the strike price, and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. In the case of a European option, the owner has the right to require the sale to take place on (but not before) the maturity date; in the case of an American option, the owner can require the sale to take place at any time up to the maturity date. If the owner of the contract exercises this right, the counter-party has the obligation to carry out the transaction. Options are of two types: call option and put option.
 * 4) Binary options: contracts that provide the owner with an all-or-nothing profit profile.
 * 5) Warrants: apart from the commonly used short-dated options which have a maximum maturity period of one year, there exist certain long-dated options as well, known as warrants. These are generally traded over the counter.
 * 6) Swaps: contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies exchange rates, bonds/interest rates, commodities exchange, stocks or other assets.
 * Swaps can basically be categorized into Interest rate swap and Currency swap.

Some common examples of these derivatives are the following:

Collateralized debt obligation
A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). An "asset-backed security" is used as an umbrella term for a type of security backed by a pool of assets—including collateralized debt obligations and mortgage-backed securities (MBS) (Example: "The capital market in which asset-backed securities are issued and traded is composed of three main categories: ABS, MBS and CDOs". )—and sometimes for a particular type of that security—one backed by consumer loans (example: "As a rule of thumb, securitization issues backed by mortgages are called MBS, and securitization issues backed by debt obligations are called CDO, [and] Securitization issues backed by consumer-backed products—car loans, consumer loans and credit cards, among others—are called ABS.) Originally developed for the corporate debt markets, over time CDOs evolved to encompass the mortgage and mortgage-backed security (MBS) markets.

Like other private-label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. The CDO is "sliced" into "tranches", which "catch" the cash flow of interest and principal payments in sequence based on seniority. If some loans default and the cash collected by the CDO is insufficient to pay all of its investors, those in the lowest, most "junior" tranches suffer losses first. The last to lose payment from default are the safest, most senior tranches. Consequently, coupon payments (and interest rates) vary by tranche with the safest/most senior tranches paying the lowest and the lowest tranches paying the highest rates to compensate for higher default risk. As an example, a CDO might issue the following tranches in order of safeness: Senior AAA (sometimes known as "super senior"); Junior AAA; AA; A; BBB; Residual.

Separate special-purpose entities—rather than the parent investment bank—issue the CDOs and pay interest to investors. As CDOs developed, some sponsors repackaged tranches into yet another iteration called "CDO-Squared" or the "CDOs of CDOs". In the early 2000s, CDOs were generally diversified, but by 2006–2007—when the CDO market grew to hundreds of billions of dollars—this changed. CDO collateral became dominated not by loans, but by lower level (BBB or A) tranches recycled from other asset-backed securities, whose assets were usually non-prime mortgages. These CDOs have been called "the engine that powered the mortgage supply chain" for nonprime mortgages, and are credited with giving lenders greater incentive to make non-prime loans leading up to the 2007-9 subprime mortgage crisis.

Credit default swap
A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer (the creditor of the reference loan) in the event of a loan default (by the debtor) or other credit event. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults. It was invented by Blythe Masters from JP Morgan in 1994. In the event of default the buyer of the CDS receives compensation (usually the face value of the loan), and the seller of the CDS takes possession of the defaulted loan. However, anyone with sufficient collateral to trade with a bank or hedge fund can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in the loan (these are called "naked" CDSs). If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction; the payment received is usually substantially less than the face value of the loan. Credit default swaps have existed since the early 1990s, and increased in use after 2003. By the end of 2007, the outstanding CDS amount was $62.2 trillion, falling to $26.3 trillion by mid-year 2010 but reportedly $25.5 trillion in early 2012. CDSs are not traded on an exchange and there is no required reporting of transactions to a government agency. During the 2007–2010 financial crisis the lack of transparency in this large market became a concern to regulators as it could pose a systemic risk.

In March 2010, the [DTCC] Trade Information Warehouse announced it would give regulators greater access to its credit default swaps database. CDS data can be used by financial professionals, regulators, and the media to monitor how the market views credit risk of any entity on which a CDS is available, which can be compared to that provided by credit rating agencies. U.S. courts may soon be following suit. Most CDSs are documented using standard forms drafted by the International Swaps and Derivatives Association (ISDA), although there are many variants. In addition to the basic, single-name swaps, there are basket default swaps (BDSs), index CDSs, funded CDSs (also called credit-linked notes), as well as loan-only credit default swaps (LCDS). In addition to corporations and governments, the reference entity can include a special-purpose vehicle issuing asset-backed securities. Some claim that derivatives such as CDS are potentially dangerous in that they combine priority in bankruptcy with a lack of transparency. A CDS can be unsecured (without collateral) and be at higher risk for a default.

Forwards
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or to sell an asset at a specified future time at an amount agreed upon today, making it a type of derivative instrument. This is in contrast to a spot contract, which is an agreement to buy or sell an asset on its spot date, which may vary depending on the instrument, for example most of the FX contracts have Spot Date two business days from today. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price agreed upon is called the delivery price, which is equal to the forward price at the time the contract is entered into. The price of the underlying instrument, in whatever form, is paid before control of the instrument changes. This is one of the many forms of buy/sell orders where the time and date of trade is not the same as the value date where the securities themselves are exchanged.

The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands on the spot date. The difference between the spot and the forward price is the forward premium or forward discount, generally considered in the form of a profit, or loss, by the purchasing party. Forwards, like other derivative securities, can be used to hedge risk (typically currency or exchange rate risk), as a means of speculation, or to allow a party to take advantage of a quality of the underlying instrument which is time-sensitive.

A closely related contract is a futures contract; they differ in certain respects. Forward contracts are very similar to futures contracts, except they are not exchange-traded, or defined on standardized assets. Forwards also typically have no interim partial settlements or "true-ups" in margin requirements like futures—such that the parties do not exchange additional property securing the party at gain and the entire unrealized gain or loss builds up while the contract is open. However, being traded over the counter (OTC), forward contracts specification can be customized and may include mark-to-market and daily margin calls. Hence, a forward contract arrangement might call for the loss party to pledge collateral or additional collateral to better secure the party at gain. In other words, the terms of the forward contract will determine the collateral calls based upon certain "trigger" events relevant to a particular counterparty such as among other things, credit ratings, value of assets under management or redemptions over a specific time frame (e.g., quarterly, annually).

Futures
In finance, a 'futures contract' (more colloquially, futures) is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the futures price) with delivery and payment occurring at a specified future date, the delivery date, making it a derivative product (i.e. a financial product that is derived from an underlying asset). The contracts are negotiated at a futures exchange, which acts as an intermediary between buyer and seller. The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, is said to be "long", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be "short".

While the futures contract specifies a trade taking place in the future, the purpose of the futures exchange is to act as intermediary and mitigate the risk of default by either party in the intervening period. For this reason, the futures exchange requires both parties to put up an initial amount of cash (performance bond), the margin. Margins, sometimes set as a percentage of the value of the futures contract, need to be proportionally maintained at all times during the life of the contract to underpin this mitigation because the price of the contract will vary in keeping with supply and demand and will change daily and thus one party or the other will theoretically be making or losing money. To mitigate risk and the possibility of default by either party, the product is marked to market on a daily basis whereby the difference between the prior agreed-upon price and the actual daily futures price is settled on a daily basis. This is sometimes known as the variation margin where the futures exchange will draw money out of the losing party's margin account and put it into the other party's thus ensuring that the correct daily loss or profit is reflected in the respective account. If the margin account goes below a certain value set by the Exchange, then a margin call is made and the account owner must replenish the margin account. This process is known as "marking to market". Thus on the delivery date, the amount exchanged is not the specified price on the contract but the spot value (i.e., the original value agreed upon, since any gain or loss has already been previously settled by marking to market). Upon marketing the strike price is often reached and creates much income for the "caller".

A closely related contract is a forward contract. A forward is like a futures in that it specifies the exchange of goods for a specified price at a specified future date. However, a forward is not traded on an exchange and thus does not have the interim partial payments due to marking to market. Nor is the contract standardized, as on the exchange. Unlike an option, both parties of a futures contract must fulfill the contract on the delivery date. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position can close out its contract obligations by taking the opposite position on another futures contract on the same asset and settlement date. The difference in futures prices is then a profit or loss.

Mortgage-backed securities
A mortgage-backed security (MBS) is an asset-backed security that is secured by a mortgage, or more commonly a collection ("pool") of sometimes hundreds of mortgages. The mortgages are sold to a group of individuals (a government agency or investment bank) that "securitizes", or packages, the loans together into a security that can be sold to investors. The mortgages of an MBS may be residential or commercial, depending on whether it is an Agency MBS or a Non-Agency MBS; in the United States they may be issued by structures set up by government-sponsored enterprises like Fannie Mae or Freddie Mac, or they can be "private-label", issued by structures set up by investment banks. The structure of the MBS may be known as "pass-through", where the interest and principal payments from the borrower or homebuyer pass through it to the MBS holder, or it may be more complex, made up of a pool of other MBSs. Other types of MBS include collateralized mortgage obligations (CMOs, often structured as real estate mortgage investment conduits) and collateralized debt obligations (CDOs).

The shares of subprime MBSs issued by various structures, such as CMOs, are not identical but rather issued as tranches (French for "slices"), each with a different level of priority in the debt repayment stream, giving them different levels of risk and reward. Tranches—especially the lower-priority, higher-interest tranches—of an MBS are/were often further repackaged and resold as collaterized debt obligations. These subprime MBSs issued by investment banks were a major issue in the subprime mortgage crisis of 2006–2008 . The total face value of an MBS decreases over time, because like mortgages, and unlike bonds, and most other fixed-income securities, the principal in an MBS is not paid back as a single payment to the bond holder at maturity but rather is paid along with the interest in each periodic payment (monthly, quarterly, etc.). This decrease in face value is measured by the MBS's "factor", the percentage of the original "face" that remains to be repaid.

Options
In finance, an option is a contract which gives the buyer (the owner) the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price on or before a specified date. The seller has the corresponding obligation to fulfill the transaction—that is to sell or buy—if the buyer (owner) "exercises" the option. The buyer pays a premium to the seller for this right. An option that conveys to the owner the right to buy something at a certain price is a "call option"; an option that conveys the right of the owner to sell something at a certain price is a "put option". Both are commonly traded, but for clarity, the call option is more frequently discussed. Options valuation is a topic of ongoing research in academic and practical finance. In basic terms, the value of an option is commonly decomposed into two parts:
 * The first part is the "intrinsic value", defined as the difference between the market value of the underlying and the strike price of the given option.
 * The second part is the "time value", which depends on a set of other factors which, through a multivariable, non-linear interrelationship, reflect the discounted expected value of that difference at expiration.

Although options valuation has been studied since the 19th century, the contemporary approach is based on the Black–Scholes model, which was first published in 1973.

Options contracts have been known for many centuries. However, both trading activity and academic interest increased when, as from 1973, options were issued with standardized terms and traded through a guaranteed clearing house at the Chicago Board Options Exchange. Today, many options are created in a standardized form and traded through clearing houses on regulated options exchanges, while other over-the-counter options are written as bilateral, customized contracts between a single buyer and seller, one or both of which may be a dealer or market-maker. Options are part of a larger class of financial instruments known as derivative products or simply derivatives.

Swaps
A swap is a derivative in which two counterparties exchange cash flows of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in question can be the periodic interest (coupon) payments associated with such bonds. Specifically, two counterparties agree to the exchange one stream of cash flows against another stream. These streams are called the swap's "legs". The swap agreement defines the dates when the cash flows are to be paid and the way they are accrued and calculated. Usually at the time when the contract is initiated, at least one of these series of cash flows is determined by an uncertain variable such as a floating interest rate, foreign exchange rate, equity price, or commodity price.

The cash flows are calculated over a notional principal amount. Contrary to a future, a forward or an option, the notional amount is usually not exchanged between counterparties. Consequently, swaps can be in cash or collateral. Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the expected direction of underlying prices.

Swaps were first introduced to the public in 1981 when IBM and the World Bank entered into a swap agreement. Today, swaps are among the most heavily traded financial contracts in the world: the total amount of interest rates and currency swaps outstanding is more than $348 trillion in 2010, according to the Bank for International Settlements (BIS). The five generic types of swaps, in order of their quantitative importance, are: interest rate swaps, currency swaps, credit swaps, commodity swaps and equity swaps (there are many other types).

Economic function of the derivative market
Some of the salient economic functions of the derivative market include: In a nutshell, there is a substantial increase in savings and investment in the long run due to augmented activities by derivative market participant.
 * 1) Prices in a structured derivative market not only replicate the discernment of the market participants about the future but also lead the prices of underlying to the professed future level. On the expiration of the derivative contract, the prices of derivatives congregate with the prices of the underlying.  Therefore, derivatives are essential tools to determine both current and future prices.
 * 2) The derivatives market reallocates risk from the people who prefer risk aversion to the people who have an appetite for risk.
 * 3) The intrinsic nature of derivatives market associates them to the underlying spot market. Due to derivatives there is a considerable increase in trade volumes of the underlying spot market. The dominant factor behind such an escalation is increased participation by additional players who would not have otherwise participated due to absence of any procedure to transfer risk.
 * 4) As supervision, reconnaissance of the activities of various participants becomes tremendously difficult in assorted markets; the establishment of an organized form of market becomes all the more imperative. Therefore, in the presence of an organized derivatives market, speculation can be controlled, resulting in a more meticulous environment.
 * 5) Third parties can use publicly available derivative prices as educated predictions of uncertain future outcomes, for example, the likelihood that a corporation will default on its debts.

Market and arbitrage-free prices
Two common measures of value are:
 * Market price, i.e. the price at which traders are willing to buy or sell the contract
 * Arbitrage-free price, meaning that no risk-free profits can be made by trading in these contracts (see rational pricing)

Determining the market price
For exchange-traded derivatives, market price is usually transparent (often published in real time by the exchange, based on all the current bids and offers placed on that particular contract at any one time). Complications can arise with OTC or floor-traded contracts though, as trading is handled manually, making it difficult to automatically broadcast prices. In particular with OTC contracts, there is no central exchange to collate and disseminate prices.

Determining the arbitrage-free price
The arbitrage-free price for a derivatives contract can be complex, and there are many different variables to consider. Arbitrage-free pricing is a central topic of financial mathematics. For futures/forwards the arbitrage free price is relatively straightforward, involving the price of the underlying together with the cost of carry (income received less interest costs), although there can be complexities.

However, for options and more complex derivatives, pricing involves developing a complex pricing model: understanding the stochastic process of the price of the underlying asset is often crucial. A key equation for the theoretical valuation of options is the Black–Scholes formula, which is based on the assumption that the cash flows from a European stock option can be replicated by a continuous buying and selling strategy using only the stock. A simplified version of this valuation technique is the binomial options model.

OTC represents the biggest challenge in using models to price derivatives. Since these contracts are not publicly traded, no market price is available to validate the theoretical valuation. Most of the model's results are input-dependent (meaning the final price depends heavily on how we derive the pricing inputs). Therefore, it is common that OTC derivatives are priced by Independent Agents that both counterparties involved in the deal designate upfront (when signing the contract).

Risks
Derivatives are often subject to the following criticisms; particularly since the Financial crisis of 2007–2008, the discipline of Risk management has developed attempting to address the below and other risks - see.

Hidden tail risk
According to Raghuram Rajan, a former chief economist of the International Monetary Fund (IMF), "... it may well be that the managers of these firms [investment funds] have figured out the correlations between the various instruments they hold and believe they are hedged. Yet as Chan and others (2005) point out, the lessons of summer 1998 following the default on Russian government debt is that correlations that are zero or negative in normal times can turn overnight to one – a phenomenon they term "phase lock-in". A hedged position "can become unhedged at the worst times, inflicting substantial losses on those who mistakenly believe they are protected". See the FRTB framework, which seeks to address this to some extent.

Leverage
The use of derivatives can result in large losses because of the use of leverage, or borrowing. Derivatives allow investors to earn large returns from small movements in the underlying asset's price. However, investors could lose large amounts if the price of the underlying moves against them significantly. There have been several instances of massive losses in derivative markets, such as the following:

 * American International Group (AIG) lost more than US$18 billion through a subsidiary over the preceding three quarters on credit default swaps (CDSs). The United States Federal Reserve Bank announced the creation of a secured credit facility of up to US$85 billion, to prevent the company's collapse by enabling AIG to meet its obligations to deliver additional collateral to its credit default swap trading partners.
 * The loss of US$7.2 Billion by Société Générale in January 2008 through mis-use of futures contracts.
 * The loss of US$6.4 billion in the failed fund Amaranth Advisors, which was long natural gas in September 2006 when the price plummeted.
 * The loss of US$4.6 billion in the failed fund Long-Term Capital Management in 1998.
 * The loss of US$1.3 billion equivalent in oil derivatives in 1993 and 1994 by Metallgesellschaft AG.
 * The loss of US$1.2 billion equivalent in equity derivatives in 1995 by Barings Bank.
 * UBS AG, Switzerland's biggest bank, suffered a $2 billion loss through unauthorized trading discovered in September 2011.

Derivatives typically have a large notional value. As such, there is the danger that their use could result in losses for which the investor would be unable to compensate. The possibility that this could lead to a chain reaction ensuing in an economic crisis was pointed out by famed investor Warren Buffett in Berkshire Hathaway's 2002 annual report. Buffett called them 'financial weapons of mass destruction.' A potential problem with derivatives is that they comprise an increasingly larger notional amount of assets which may lead to distortions in the underlying capital and equities markets themselves. Investors begin to look at the derivatives markets to make a decision to buy or sell securities and so what was originally meant to be a market to transfer risk now becomes a leading indicator.(See Berkshire Hathaway Annual Report for 2002)

Counterparty risk
Some derivatives (especially swaps) expose investors to counterparty risk, or risk arising from the other party in a financial transaction. Counterparty risk results from the differences in the current price versus the expected future settlement price. Different types of derivatives have different levels of counter party risk. For example, standardized stock options by law require the party at risk to have a certain amount deposited with the exchange, showing that they can pay for any losses; banks that help businesses swap variable for fixed rates on loans may do credit checks on both parties. However, in private agreements between two companies, for example, there may not be benchmarks for performing due diligence and risk analysis.

Financial reform and government regulation
Under US law and the laws of most other developed countries, derivatives have special legal exemptions that make them a particularly attractive legal form to extend credit. The strong creditor protections afforded to derivatives counterparties, in combination with their complexity and lack of transparency however, can cause capital markets to underprice credit risk. This can contribute to credit booms, and increase systemic risks. Indeed, the use of derivatives to conceal credit risk from third parties while protecting derivative counterparties contributed to the financial crisis of 2008 in the United States.

In the context of a 2010 examination of the ICE Trust, an industry self-regulatory body, Gary Gensler, the chairman of the Commodity Futures Trading Commission which regulates most derivatives, was quoted saying that the derivatives marketplace as it functions now "adds up to higher costs to all Americans". More oversight of the banks in this market is needed, he also said. Additionally, the report said, "[t]he Department of Justice is looking into derivatives, too. The department's antitrust unit is actively investigating 'the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries', according to a department spokeswoman."

For legislators and committees responsible for financial reform related to derivatives in the United States and elsewhere, distinguishing between hedging and speculative derivatives activities has been a nontrivial challenge. The distinction is critical because regulation should help to isolate and curtail speculation with derivatives, especially for "systemically significant" institutions whose default could be large enough to threaten the entire financial system. At the same time, the legislation should allow for responsible parties to hedge risk without unduly tying up working capital as collateral that firms may better employ elsewhere in their operations and investment. In this regard, it is important to distinguish between financial (e.g. banks) and non-financial end-users of derivatives (e.g. real estate development companies) because these firms' derivatives usage is inherently different. More importantly, the reasonable collateral that secures these different counterparties can be very different. The distinction between these firms is not always straight forward (e.g. hedge funds or even some private equity firms do not neatly fit either category). Finally, even financial users must be differentiated, as 'large' banks may classified as "systemically significant" whose derivatives activities must be more tightly monitored and restricted than those of smaller, local and regional banks.

Over-the-counter dealing will be less common as the Dodd–Frank Wall Street Reform and Consumer Protection Act comes into effect. The law mandated the clearing of certain swaps at registered exchanges and imposed various restrictions on derivatives. To implement Dodd-Frank, the CFTC developed new rules in at least 30 areas. The Commission determines which swaps are subject to mandatory clearing and whether a derivatives exchange is eligible to clear a certain type of swap contract.

Nonetheless, the above and other challenges of the rule-making process have delayed full enactment of aspects of the legislation relating to derivatives. The challenges are further complicated by the necessity to orchestrate globalized financial reform among the nations that comprise the world's major financial markets, a primary responsibility of the Financial Stability Board whose progress is ongoing.

In the U.S., by February 2012 the combined effort of the SEC and CFTC had produced over 70 proposed and final derivatives rules. However, both of them had delayed adoption of a number of derivatives regulations because of the burden of other rule-making, litigation and opposition to the rules, and many core definitions (such as the terms "swap", "security-based swap", "swap dealer", "security-based swap dealer", "major swap participant" and "major security-based swap participant") had still not been adopted. SEC Chairman Mary Schapiro opined: "At the end of the day, it probably does not make sense to harmonize everything [between the SEC and CFTC rules] because some of these products are quite different and certainly the market structures are quite different." On February 11, 2015, the Securities and Exchange Commission (SEC) released two final rules toward establishing a reporting and public disclosure framework for security-based swap transaction data. The two rules are not completely harmonized with the requirements with CFTC requirements.

In November 2012, the SEC and regulators from Australia, Brazil, the European Union, Hong Kong, Japan, Ontario, Quebec, Singapore, and Switzerland met to discuss reforming the OTC derivatives market, as had been agreed by leaders at the 2009 G-20 Pittsburgh summit in September 2009. In December 2012, they released a joint statement to the effect that they recognized that the market is a global one and "firmly support the adoption and enforcement of robust and consistent standards in and across jurisdictions", with the goals of mitigating risk, improving transparency, protecting against market abuse, preventing regulatory gaps, reducing the potential for arbitrage opportunities, and fostering a level playing field for market participants. They also agreed on the need to reduce regulatory uncertainty and provide market participants with sufficient clarity on laws and regulations by avoiding, to the extent possible, the application of conflicting rules to the same entities and transactions, and minimizing the application of inconsistent and duplicative rules. At the same time, they noted that "complete harmonization – perfect alignment of rules across jurisdictions" would be difficult, because of jurisdictions' differences in law, policy, markets, implementation timing, and legislative and regulatory processes.

On December 20, 2013 the CFTC provided information on its swaps regulation "comparability" determinations. The release addressed the CFTC's cross-border compliance exceptions. Specifically it addressed which entity level and in some cases transaction-level requirements in six jurisdictions (Australia, Canada, the European Union, Hong Kong, Japan, and Switzerland) it found comparable to its own rules, thus permitting non-US swap dealers, major swap participants, and the foreign branches of US Swap Dealers and major swap participants in these jurisdictions to comply with local rules in lieu of Commission rules.

Reporting
Mandatory reporting regulations are being finalized in a number of countries, such as Dodd Frank Act in the US, the European Market Infrastructure Regulations (EMIR) in Europe, as well as regulations in Hong Kong, Japan, Singapore, Canada, and other countries. The OTC Derivatives Regulators Forum (ODRF), a group of over 40 worldwide regulators, provided trade repositories with a set of guidelines regarding data access to regulators, and the Financial Stability Board and CPSS IOSCO also made recommendations in with regard to reporting.

DTCC, through its "Global Trade Repository" (GTR) service, manages global trade repositories for interest rates, and commodities, foreign exchange, credit, and equity derivatives. It makes global trade reports to the CFTC in the U.S., and plans to do the same for ESMA in Europe and for regulators in Hong Kong, Japan, and Singapore. It covers cleared and uncleared OTC derivatives products, whether or not a trade is electronically processed or bespoke.

Glossary

 * Bilateral netting: A legally enforceable arrangement between a bank and a counter-party that creates a single legal obligation covering all included individual contracts. This means that a bank's obligation, in the event of the default or insolvency of one of the parties, would be the net sum of all positive and negative fair values of contracts included in the bilateral netting arrangement.
 * Counterparty: The legal and financial term for the other party in a financial transaction.
 * Credit derivative: A contract that transfers credit risk from a protection buyer to a credit protection seller. Credit derivative products can take many forms, such as credit default swaps, credit linked notes and total return swaps.
 * Derivative: A financial contract whose value is derived from the performance of assets, interest rates, currency exchange rates, or indexes. Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards and various combinations thereof.
 * Exchange-traded derivative contracts: Standardized derivative contracts (e.g., futures contracts and options) that are transacted on an organized futures exchange.
 * Gross negative fair value: The sum of the fair values of contracts where the bank owes money to its counter-parties, without taking into account netting. This represents the maximum losses the bank's counter-parties would incur if the bank defaults and there is no netting of contracts, and no bank collateral was held by the counter-parties.
 * Gross positive fair value: The sum total of the fair values of contracts where the bank is owed money by its counter-parties, without taking into account netting. This represents the maximum losses a bank could incur if all its counter-parties default and there is no netting of contracts, and the bank holds no counter-party collateral.
 * High-risk mortgage securities: Securities where the price or expected average life is highly sensitive to interest rate changes, as determined by the U.S. Federal Financial Institutions Examination Council policy statement on high-risk mortgage securities.
 * Notional amount: The nominal or face amount that is used to calculate payments made on swaps and other risk management products. This amount generally does not change hands and is thus referred to as notional.
 * Over-the-counter (OTC) derivative contracts: Privately negotiated derivative contracts that are transacted off organized futures exchanges.
 * Structured notes: Non-mortgage-backed debt securities, whose cash flow characteristics depend on one or more indices and / or have embedded forwards or options.
 * Total risk-based capital: The sum of tier 1 plus tier 2 capital. Tier 1 capital consists of common shareholders equity, perpetual preferred shareholders equity with noncumulative dividends, retained earnings, and minority interests in the equity accounts of consolidated subsidiaries. Tier 2 capital consists of subordinated debt, intermediate-term preferred stock, cumulative and long-term preferred stock, and a portion of a bank's allowance for loan and lease losses.

title: Derivative (finance)


text:
Disney (disambiguation)

Disney is a name colloquially given to The Walt Disney Company, an American diversified multinational mass media and entertainment conglomerate.

The term Disney may also refer to:

 * Walt Disney (1901–1966), founder of the Walt Disney Company

Units of The Walt Disney Company

 * Disney Enterprises, Inc., the copyright holder and trademark owner of everything Disney-branded
 * Walt Disney Studios (Burbank), the company headquarters and studio lot in Burbank, California
 * Walt Disney Studios (division), the film studios division of The Walt Disney Company
 * Walt Disney Studios Motion Pictures, the theatrical distribution division of The Walt Disney Company
 * Walt Disney Pictures, the film distribution banner and production company of The Walt Disney Company
 * Walt Disney Animation Studios, the main animation studio (formerly known as Walt Disney Feature Animation)
 * Walt Disney Studios Home Entertainment, the home entertainment distribution division of The Walt Disney Company
 * Disney Theatrical Group, the live show, stageplay and musical production arm of The Walt Disney Company
 * Disney Theatrical Productions, the flagship stageplay and musical production division of The Walt Disney Company
 * Disney Music Group, the music publishing arm of The Walt Disney Company
 * Walt Disney Records, the flagship Disney-branded music label
 * Disney Parks, Experiences and Products, the division which builds and manages Disney's theme parks and vacation resorts, Disney Stores, merchandising, publishing and digital media, games and interactive experiences
 * Walt Disney World
 * Disneyland Resort
 * Disneyland
 * Disney California Adventure
 * Disneyland Paris
 * Hong Kong Disneyland Resort
 * Tokyo Disney Resort
 * Shanghai Disney Resort
 * Disney Signature Experiences, non-theme park travel units
 * Adventures by Disney
 * Disney Cruise Line
 * Disney's Castaway Cay
 * Disney Vacation Club
 * Walt Disney Imagineering, the research and development arm of The Walt Disney Company responsible for the creation, design and construction of global Disney theme parks and attractions
 * Disney Publishing Worldwide, the publishing division of The Walt Disney Company
 * Disney Programs, division that provides paid internship experiences in The Walt Disney Company to college students and graduates
 * Disney College Program
 * Disney International Programs
 * Disney Media Networks, the former division before the October 10, 2020 breakup and restructuring into Disney Media and Entertainment Distribution, Disney General Entertainment Content and ESPN and Sports Content
 * Walt Disney Television — rebranded as "Disney General Entertainment Content" or "Disney General Entertainment" in 2021
 * Disney Channel, a pay television network owned by The Walt Disney Company
 * Walt Disney Television, a broken-up and defunct American television production company arm of The Walt Disney Company active from 1983 to 2003
 * Disney Television Animation, the television animation studio division of The Walt Disney Company
 * Capital Disney, a defunct digital radio station in the United Kingdom owned by The Walt Disney Company which was active from 2002 until 2007
 * Radio Disney, a defunct radio network in the United States owned by The Walt Disney Company which was active from 1996 until 2021
 * Disney+, a streaming service launched on November 12, 2019 and is owned and operated by The Walt Disney Company

Relatives of Walt Disney

 * Roy O. Disney (1893–1971), Walt's brother and co-founder of The Walt Disney Company
 * Roy E. Disney (1930–2009), son of Roy O. and leader of the Save Disney campaign
 * Abigail Disney (born 1960), Walt's grandniece, philanthropist and film-maker
 * Lillian Disney (1899–1997), Walt's wife
 * Elias Disney (1859–1941), father of Walt and Roy O.
 * Herbert Arthur Disney (1888–1961), brother of Walt and Roy O.
 * Diane Marie Disney (1933–2013), Walt's daughter
 * Sharon Mae Disney (1936–1993), Walt's adopted daughter

Others

 * David T. Disney (1803-1857), American politician from Ohio
 * Donald Disney, Fellow of the Institute of Electrical and Electronics Engineers
 * Doris Miles Disney (1907-1976), American author
 * Dorothy Cameron Disney (1903-1992), American author
 * Guy Disney British steeplechase jockey
 * John Disney (antiquarian) (1779–1857), English barrister and archaeologist
 * John Disney (ornithologist) (1919–2014), Australian ornithologist
 * John Disney (priest) (1677–1730), English clergyman
 * John Disney (Unitarian) (1746–1816), English Unitarian minister and biographical writer
 * Melissa Disney, American voice actress
 * Moore Disney (1766-1846), British Army officer
 * Richard Disney (disambiguation)
 * Wesley E. Disney, former US congressman from Oklahoma
 * Disney-Roebuck family, see Captain Disney-Roebuck

Other uses

 * Disney, Oklahoma, United States
 * Disney bomb, a British "rocket-assisted" bomb of World War II

license: Creative Commons - Attribution Share-Alike - https://creativecommons.org/licenses/by-sa/4.0/

title: Disney (disambiguation)


text:
Divine right of kings

In European Christianity, the divine right of kings, divine right, or God's mandation, is a political and religious doctrine of political legitimacy of a monarchy. It is also known as the divine-right theory of kingship.

The doctrine asserts that a monarch is not accountable to any earthly authority (such as a parliament or the Pope) because their right to rule is derived from divine authority. Thus, the monarch is not subject to the will of the people, of the aristocracy, or of any other estate of the realm. It follows that only divine authority can judge a monarch, and that any attempt to depose, dethrone, resist or restrict their powers runs contrary to God's will and may constitute a sacrilegious act. It does not imply that their power is absolute.

In its full-fledged form, the Divine Right of Kings is associated with Henry VIII of England (and the Acts of Supremacy), James VI and I of Scotland and England, Louis XIV of France, and their successors.

In contrast, the conception of human rights started being developed during the Middle Ages by scholars such as St. Thomas Aquinas (see Natural Law) and were systematised by the thinkers of the Age of Enlightenment, e.g. John Locke. Liberty, dignity, freedom and equality are examples of important human rights.

Concepts
Divine right has been a key element of the self-legitimisation of many absolute monarchies, connected with their authority and right to rule. Related but distinct notions include Caesaropapism (the complete subordination of bishops etc. to the secular power), Supremacy (the legal sovereignty of the civil laws over the laws of the Church), Absolutism (a form of monarchical or despotic power that is unrestrained by all other institutions, such as churches, legislatures, or social elites) or Tyranny (an absolute ruler who is unrestrained even by moral law).

Historically, many notions of rights have been authoritarian and hierarchical, with different people granted different rights and some having more rights than others. For instance, the right of a father to receive respect from his son did not indicate a right for the son to receive a return from that respect. Analogously, the divine right of kings, which permitted absolute power over subjects, provided few rights for the subjects themselves.

It is sometimes signified by the phrase "by the Grace of God" or its Latin equivalent, Dei Gratia, which has historically been attached to the titles of certain reigning monarchs. Note, however, that such accountability only to God does not per se make the monarch a sacred king.

Zoroastrianism (Iranian world)

Khvarenah (also spelled khwarenah or xwarra(h): 𐬓𐬀𐬭𐬆𐬥𐬀𐬵 xᵛarənah; ) is an Iranian and Zoroastrian concept, which literally means glory, about divine right of the kings. This may stem from early Mesopotamian culture, where kings were often regarded as deities after their death. Shulgi of Ur was among the first Mesopotamian rulers to declare himself to be divine. In the Iranian view, kings would never rule, unless Khvarenah is with them, and they will never fall unless Khvarenah leaves them. For example, according to the Kar-namag of Ardashir, when Ardashir I of Persia and Artabanus V of Parthia fought for the throne of Iran, on the road Artabanus and his contingent are overtaken by an enormous ram, which is also following Ardashir. Artabanus's religious advisors explain to him that the ram is the manifestation of the khwarrah of the ancient Iranian kings, which is leaving Artabanus to join Ardashir.

Roman Empire
The Imperial cult of ancient Rome identified Roman emperors and some members of their families with the "divinely sanctioned" authority (auctoritas) of the Roman State. The official offer of cultus to a living emperor acknowledged his office and rule as divinely approved and constitutional: his Principate should therefore demonstrate pious respect for traditional Republican deities and mores. Many of the rites, practices and status distinctions that characterized the cult to emperors were perpetuated in the theology and politics of the Christianised Empire.

Judaism
While the earliest references to kingship in Israel proclaim that "14 "When you come to the land that the Lord your God is giving you, and you possess it and dwell in it and then say, 'I will set a king over me, like all the nations that are around me,' 15 you may indeed set a king over you whom the Lord your God will choose. One from among your brothers you shall set as king over you. You may not put a foreigner over you, who is not your brother." (Deut 17:14-15), significant debate on the legitimacy of kingship has persisted in Rabbinical Judaism until Maimonides, though many mainstream currents continue to reject the notion.

The controversy is highlighted by the instructions to the Israelites in the above-quoted passage, as well as the passages in 1 Samuel 8 and 12, concerning the dispute over kingship; and Perashat Shoftim. It is from 1 Samuel 8 that the Jews receive mishpat ha-melech, the ius regium, or the law of kingship, and from this passage that Maimonides finally concludes that Judaism supports the institution of monarchy, stating that the Israelites had been given three commandments upon entering the land of Israel - to designate a king for themselves, to wipe out the memory of Amalek, and to build the Temple.

The debate has primarily centered around the problem of being told to "designate" a king, which some rabbinical sources have argued is an invocation against a divine right of kings, and a call to elect a leader, in opposition to a notion of a divine right. Other rabbinical arguments have put forward an idea that it is through the collective decision of the people that God's will is made manifest, and that the king does therefore have a divine right - once appointed by the nation, he is God's emissary.

Jewish law requires one to recite a special blessing upon seeing a monarch: "Blessed are You, L‑rd our G‑d, King of the universe, Who has given from His glory to flesh and blood".

European conceptions
With the rise of firearms, nation-states and the Protestant Reformation in the late 16th century, the theory of divine right justified the king's absolute authority in both political and spiritual matters. Henry VIII of England declared himself the Supreme Head of the Church of England and exerted the power of the throne more than any of his predecessors.

As a political theory, it was further developed by James VI of Scotland (1567–1625) and came to the fore in England under his reign as James I of England (1603–1625). Louis XIV of France (1643–1715) strongly promoted the theory as well.

Historian J.P. Sommerville stresses the theory was polemic: "Absolutists magnified royal power. They did this to protect the state against anarchy and to refute the ideas of resistance theorists", those being in Britain Catholic and Presbyterian theorists.

The concept of divine right incorporates, but exaggerates, the ancient Christian concept of "royal God-given rights", which teach that "the right to rule is anointed by God", although this idea is found in many other cultures, including Aryan and Egyptian traditions.

In pagan religions, the king was often seen as a God incarnate and so was an unchallengeable despot. The ancient Roman Catholic tradition overcame this idea with the doctrine of the two swords and so achieved, for the very first time, a balanced constitution for states. The advent of Protestantism saw something of a return to the idea of a mere unchallengeable despot.

Biblical background
The Christian notion of a divine right of kings is traced to a story found in 1 Samuel, where the prophet Samuel anoints Saul and then David as Messiah ("anointed one")—king over Israel. In the Jewish traditions, the lack of a divine leadership represented by an anointed king, beginning shortly after the death of Joshua, left the people of Israel vulnerable, and the promise of the "promised land" was not fully fulfilled until a king was anointed by a prophet on behalf of God.

The effect of anointing was seen to be that the monarch became inviolable, so that even when Saul sought to kill David, David would not raise his hand against him because "he was the Lord's anointed". Raising a hand to a king was therefore considered to be as sacrilegious as raising a hand against God and stood on equal footing as blasphemy. In essence, the king stood in place of God and was never to be challenged "without the challenger being accused of blasphemy" - except by a prophet, which under Christianity was replaced by the church.

Medieval periods
Outside of Christianity, kings were often seen as ruling with the backing of heavenly powers.

Early Middle Ages
Although the later Roman Empire had developed the European concept of a divine regent in Late Antiquity, Adomnan of Iona provides one of the earliest written examples of a Western medieval concept of kings ruling with divine right. He wrote of the Irish King Diarmait mac Cerbaill's assassination and claimed that divine punishment fell on his assassin for the act of violating the monarch.

Adomnan also recorded a story about Saint Columba supposedly being visited by an angel carrying a glass book, who told him to ordain Aedan mac Gabrain as King of Dal Riata. Columba initially refused, and the angel answered by whipping him and demanding that he perform the ordination because God had commanded it. The same angel visited Columba on three successive nights. Columba finally agreed, and Aedan came to receive ordination. At the ordination, Columba told Aedan that so long as he obeyed God's laws, then none of his enemies would prevail against him, but the moment he broke them, this protection would end, and the same whip with which Columba had been struck would be turned against the king.

Adomnan's writings most likely influenced other Irish writers, who in turn influenced continental ideas as well. Pepin the Short's coronation may have also come from the same influence. The Byzantine Empire can be seen as the progenitor of this concept (which began with Constantine I). This in turn inspired the Carolingian dynasty and the Holy Roman Emperors, whose lasting impact on Western and Central Europe further inspired all subsequent Western ideas of kingship.

High Middle Ages
In the Middle Ages, the idea that God had granted certain earthly powers to the monarch, just as he had given spiritual authority and power to the church, especially to the Pope, was already a well-known concept long before later writers coined the term "divine right of kings" and employed it as a theory in political science.

However, the dividing line for the authority and power was a subject of frequent contention: notably in England with the murder of Archbishop Thomas Beckett (1170). For example, Richard I of England declared at his trial during the diet at Speyer in 1193: "I am born in a rank which recognizes no superior but God, to whom alone I am responsible for my actions", and it was Richard who first used the motto "Dieu et mon droit" ("God and my right") which is still the motto of the Monarch of the United Kingdom.

Thomas Aquinas condoned extra-legal tyrannicide in the worst of circumstances: "When there is no recourse to a superior by whom judgment can be made about an invader, then he who slays a tyrant to liberate his fatherland is [to be] praised and receives a reward."

- Thomas Aquinas, Commentary on the Magister Sententiarum (Sentences II, Distinction 44, question 2, article 2)

On the other hand, Aquinas forbade the overthrow of any morally, Christianly and spiritually legitimate king by his subjects. The only human power capable of deposing the king was the pope. The reasoning was that if a subject may overthrow his superior for some bad law, who was to be the judge of whether the law was bad? If the subject could so judge his own superior, then all lawful superior authority could lawfully be overthrown by the arbitrary judgement of an inferior, and thus all law was under constant threat.

According to John of Paris, kings had their jurisdictions and bishops (and the pope) had theirs, but kings derived their supreme, non-absolute temporal jurisdiction from popular consent.

Late Middle Ages and Renaissance
Towards the end of the Middle Ages, many philosophers, such as Nicholas of Cusa and Francisco Suárez, propounded similar theories.

The Church was the final guarantor that Christian kings would follow the laws and constitutional traditions of their ancestors and the laws of God and of justice.

Radical English theologian John Wycliffe's theory of Dominium meant that injuries inflicted on someone personally by a king should be born by them submissively, a conventional idea, but that injuries by a king against God should be patiently resisted even to death; gravely sinful kings and popes forfeited their (divine) right to obedience and ownership, though the political order should be maintained. More aggressive versions of this were taken up by Lollards and Hussites.

For Erasmus of Rotterdam it was the consent of the people which gives and takes away "the purple", not an unchangeable divine mandate.

Catholic limits
Catholic jurisprudence holds that the monarch is always subject to natural and divine law, which are regarded as superior to the monarch.

The possibility of monarchy declining morally, overturning natural law, and degenerating into a tyranny oppressive of the general welfare was answered theologically with the Catholic concept of the spiritual superiority of the Pope (there is no "Catholic concept of extra-legal tyrannicide", as some falsely suppose, the same being expressly condemned by St Thomas Aquinas in chapter 7 of his De Regno).

Catholic thought justified limited submission to the monarchy by reference to the following:
 * 1) The Old Testament, in which God chose kings to rule over Israel, beginning with Saul who was then rejected by God in favour of David, whose dynasty continued (at least in the southern kingdom) until the Babylonian captivity.
 * 2) The New Testament, in which the first pope, Peter, commands that all Christians shall honour the Roman Emperor, even though, at that time, he was still a pagan emperor. Paul agreed with Peter that subjects should be obedient to the powers that be because they are appointed by God, as he wrote in his Epistle to the Romans. Likewise, Jesus Christ proclaims in the Gospel of Matthew that one should "Render unto Caesar the things which are Caesar's"; that is at first, literally, the payment of taxes as binding those who use the imperial currency. Jesus told Pontius Pilate that his authority as Roman governor of Judaea came from heaven according to John 19:10–11.
 * 3) The endorsement by the popes and the church of the line of emperors beginning with the Emperors Constantine and Theodosius, later the Eastern Roman emperors, and finally the Western Roman emperor, Charlemagne and his successors, the Catholic Holy Roman Emperors.

Reformation-period conceptions
The divine right of kings, or divine-right theory of kingship, is a political and religious doctrine of royal and political legitimacy. It asserts that a monarch is subject to no earthly authority, deriving his right to rule directly from the will of God. The king is thus not subject to the will of his people, the aristocracy, or any other estate of the realm, including (in the view of some, especially in Protestant countries) the church.

A weaker or more moderate form of this political theory does hold, however, that the king is subject to the church and the pope, although completely irreproachable in other ways; but according to this doctrine in its strong form, only God can judge an unjust king.

The doctrine implies that any attempt to depose the king or to restrict his powers runs contrary to the will of God and may constitute a sacrilegious act.

Scottish
The Scots textbooks of the divine right of kings were written in 1597–1598 by James VI of Scotland. His Basilikon Doron, a manual on the powers of a king, was written to edify his four-year-old son Henry Frederick that a king "acknowledgeth himself ordained for his people, having received from God a burden of government, whereof he must be countable".

The conception of ordination brought with it largely unspoken parallels with the Anglican and Catholic priesthood, but the overriding metaphor in James VI's 'Basilikon Doron' was that of a father's relation to his children. "Just as no misconduct on the part of a father can free his children from obedience to the fifth commandment."

British
James, after becoming James I of England, also had printed his Defense of the Right of Kings in the face of English theories of inalienable popular and clerical rights.

He based his theories in part on his understanding of the Bible, as noted by the following quote from a speech to parliament delivered in 1610 as James I of England:

"The state of monarchy is the supremest thing upon earth, for kings are not only God's lieutenants upon earth and sit upon God's throne, but even by God himself, they are called gods. There be three principal [comparisons] that illustrate the state of monarchy: one taken out of the word of God, and the two other out of the grounds of policy and philosophy. In the Scriptures, kings are called gods, and so their power after a certain relation compared to the Divine power. Kings are also compared to fathers of families; for a king is true parens patriae [parent of the country], the politic father of his people. And lastly, kings are compared to the head of this microcosm of the body of man."

James's reference to "God's lieutenants" is apparently a reference to the text in Romans 13 where Paul refers to "God's ministers".

"(1) Let every soul be subject unto the higher powers. For there is no power but of God: the powers that be are ordained of God. (2) Whosoever, therefore, resisteth the power, resisteth the ordinance of God: and they that resist shall receive to themselves damnation. (3) For rulers are not a terror to good works, but to the evil. Wilt thou then not be afraid of the power? do that which is good, and thou shalt have praise of the same: (4) For he is the minister of God to thee for good. But if thou do that which is evil, be afraid; for he beareth not the sword in vain: for he is the minister of God, a revenger to execute wrath upon him that doeth evil. (5) Wherefore ye must needs be subject, not only for wrath but also for conscience sake. (6) For this cause pay ye tribute also: for they are God's ministers, attending continually upon this very thing. (7) Render therefore to all their dues: tribute to whom tribute is due; custom to whom custom; fear to whom fear; honour to whom honour."

Ceremonial conflation
Some of the symbolism within the coronation ceremony for British monarchs, in which they are anointed with holy oils by the Archbishop of Canterbury, thereby ordaining them to monarchy, perpetuates the ancient Roman Catholic monarchical ideas and ceremonial (although few Protestants realize this, the ceremony is nearly entirely based upon that of the Coronation of the Holy Roman Emperor). However, in the UK, the symbolism ends there since the real governing authority of the monarch was all but extinguished by the Whig revolution of 1688–89 (see Glorious Revolution). The king or queen of the United Kingdom is one of the last monarchs still to be crowned in the traditional Christian ceremonial, which in most other countries has been replaced by an inauguration or other declaration.

In England, it is not without significance that the sacerdotal vestments, generally discarded by the clergy – dalmatic, alb and stole – continued to be among the insignia of the sovereign (see Coronation of the British monarch). Moreover, this sacrosanct character he acquired not by virtue of his "sacring", but by hereditary right; the coronation, anointing and vesting were but the outward and visible symbol of a divine grace adherent in the sovereign by virtue of his title. Even Roman Catholic monarchs, like Louis XIV, would never have admitted that their coronation by the archbishop constituted any part of their title to reign; it was no more than the consecration of their title.

French
The French prelate Jacques-Bénigne Bossuet made a classic statement of the doctrine of divine right in a sermon preached before King Louis XIV:

"Les rois règnent par moi, dit la Sagesse éternelle: 'Per me reges regnant'; et de là nous devons conclure non seulement que les droits de la royauté sont établis par ses lois, mais que le choix des personnes est un effet de sa providence."

"Kings reign by Me, says Eternal Wisdom: "Per me reges regnant" [in Latin]; and from that we must conclude not only that the rights of royalty are established by its laws, but also that the choice of persons [to occupy the throne] is an effect of its providence."

The French Huguenot nobles and clergy, having rejected the pope and the Catholic Church, were left only with the supreme power of the king who, they taught, could not be gainsaid or judged by anyone. Since there was no longer the countervailing power of the papacy and since the Church of England was a creature of the state and had become subservient to it, this meant that there was nothing to regulate the powers of the king, and he became an absolute power. In theory, divine, natural, customary, and constitutional law still held sway over the king, but, absent a superior spiritual power, it was difficult to see how they could be enforced since the king could not be tried by any of his own courts.

German
One passage in scripture supporting the idea of the divine right of kings was used by Martin Luther, when urging the secular authorities to crush the Peasant Rebellion of 1525 in Germany in his Against the Murderous, Thieving Hordes of Peasants, basing his argument on Paul's Epistle to the Romans.

It is related to the ancient Catholic philosophies regarding monarchy, in which the monarch is God's vicegerent upon the earth and therefore subject to no inferior power.

Protestantism

Before the Reformation the anointed king was, within his realm, the accredited vicar of God for secular purposes (see the Investiture Controversy); after the Reformation he (or she if queen regnant) became this in Protestant states for religious purposes also.

Opposition
In the sixteenth century, both Catholic and Protestant political thinkers alike challenged the idea of a monarch's "divine right".

Catholic
The Spanish Catholic historian Juan de Mariana put forward the argument in his book De rege et regis institutione (1598) that since society was formed by a "pact" among all its members, "there can be no doubt that they are able to call a king to account". Mariana thus challenged divine right theories by stating in certain circumstances, tyrannicide could be justified.

Cardinal Robert Bellarmine also "did not believe that the institute of monarchy had any divine sanction" and shared Mariana's belief that there were times where Catholics could lawfully remove a monarch.

Protestant
Among groups of English Protestant exiles fleeing from Queen Mary I, some of the earliest anti-monarchist publications emerged. "Weaned off uncritical royalism by the actions of Queen Mary ... The political thinking of men like Ponet, Knox, Goodman and Hales."

In 1553, Mary I, a Roman Catholic, succeeded her Protestant half-brother, Edward VI, to the English throne. Mary set about trying to restore Roman Catholicism by making sure that: Edward's religious laws were abolished in the Statute of Repeal Act (1553); the Protestant religious laws passed in the time of Henry VIII were repealed; and the Revival of the Heresy Acts were passed in late 1554.

When Thomas Wyatt the Younger instigated what became known as Wyatt's rebellion in early 1554, John Ponet, the highest-ranking ecclesiastic among the exiles, allegedly participated in the uprising. He escaped to Strasbourg after the Rebellion's defeat and, the following year, he published A Shorte Treatise of Politike Power, in which he put forward a theory of justified opposition to secular rulers.

"Ponet's treatise comes first in a new wave of anti-monarchical writings ... It has never been assessed at its true importance, for it antedates by several years those more brilliantly expressed but less radical Huguenot writings which have usually been taken to represent the Tyrannicide-theories of the Reformation."

- A.G. Dickens

Ponet's pamphlet was republished on the eve of King Charles I's execution.

Enlightenment
According to U.S. President John Adams, Ponet's work contained "all the essential principles of liberty, which were afterward dilated on by Sidney and Locke", including the idea of a three-branched government.

Over time, opposition to the divine right of kings came from a number of sources, including poet John Milton in his pamphlet The Tenure of Kings and Magistrates, and Thomas Paine in his pamphlet Common Sense. By 1700 an Anglican Archbishop was prepared to  assert  that  Kings hold their Crowns  by law alone, and  the  law  may forfeit  them.

Probably the two most famous declarations of a right to revolution against tyranny in the English language are John Locke's Essay concerning The True Original, Extent, and End of Civil-Government and Thomas Jefferson's formulation in the United States Declaration of Independence that "all men are created equal".

Peak and decline

In England the doctrine of the divine right of kings was developed to its most extreme logical conclusions during the political controversies of the 17th century; its most famous exponent was Sir Robert Filmer. It was the main issue to be decided by the English Civil War, the Royalists holding that "all Christian kings, princes and governors" derive their authority direct from God, the Parliamentarians that this authority is the outcome of a contract, actual or implied, between sovereign and people.

In one case the king's power would be unlimited, according to the famous saying misattributed to Louis XIV: "L' état, c'est moi", or limited only by his own free act; in the other his actions would be governed by the advice and consent of the people, to whom he would be ultimately responsible. The victory of this latter principle was proclaimed to all the world by the execution of Charles I.

The doctrine of divine right, indeed, for a while drew nourishment from the blood of the royal "martyr"; it was the guiding principle of the Anglican Church of the Restoration; but it suffered a rude blow when James II of England made it impossible for the clergy to obey both their conscience and their king.

The Glorious Revolution of 1688 made an end of it as a great political force. This has led to the constitutional development of the Crown in Britain, as held by descent modified and modifiable by parliamentary action.

Related concepts in other religions

 * Mandate of Heaven and monarch as the Son of Heaven - Sinosphere
 * Madkhalism - Islam
 * Monarchs who are also deities:
 * God emperors
 * God kings
 * Sacred kings - the occupant of the monarchy gains religious significance or has support from a deity
 * Cakravartin - South Asia
 * Kut - Central Asia

title: Divine right of kings