Derivative Instrument and Derivative Market Features

The asset from which a derivative derives its value. This could be a single asset or a group of standardized assets or variables like interest rates or credit indexes.

An example of a derivative where parties agree to exchange an asset at a predetermined future date and price. It allows the transfer of price risk from one party to another.

The risk that the other party in the derivative contract will not fulfill their financial obligations. This is a critical consideration in derivatives.

The length of time until the closing of the transaction or settlement in a derivative contract.

The amount used for calculation to price and value the derivative, agreed upon at the start of the contract.

Types of derivatives where a firm commitment involves a predetermined exchange at settlement, and a contingent claim depends on certain conditions being met.

The use of derivatives to offset or neutralize existing or anticipated exposures to an underlying asset, effectively managing risk.

Equity derivatives may reference individual stocks, groups of stocks, or stock indices. Common forms include options, forwards, futures, and swaps, which can be used for hedging or adjusting market exposure.

These derivatives are based on bonds or interest rates, with common derivatives being options, forwards, futures, and swaps. They are used to manage interest rate exposure and adjust portfolio duration.

Currency derivatives help manage the risks associated with foreign exchange fluctuations. These derivatives include options, forwards, futures, and swaps, and are used by exporters, importers, and investors to hedge against currency risk.

Commodity derivatives are used to hedge against price volatility of raw materials, such as oil, metals, and agricultural products. These derivatives can be used for hedging operational costs or for speculative purposes.

Credit derivatives are based on the default risk of entities and are used to manage credit exposure. Credit default swaps (CDS) are a common form, allowing investors to speculate on or hedge against credit events.

Includes less common derivatives based on underlyings like weather, cryptocurrencies, and longevity risks. These derivatives are typically more complex and specialized.

OTC derivative markets involve contracts between end users and dealers or financial intermediaries. These contracts are customizable, allowing for specific risk exposure profiles tailored to the needs of the end users. OTC markets are less transparent and can involve higher counterparty risk.

ETD markets include standardized financial contracts such as futures and options traded on formal exchanges. These markets offer greater liquidity, lower trading costs, and reduced counterparty risk due to standardization and the involvement of a central counterparty.

Post-2008 financial crisis, central clearing became mandatory for most OTC derivatives to manage credit risk. A central counterparty (CCP) assumes the credit risk between counterparties, enhancing transparency and reducing systemic risk.

Different market participants may choose between OTC and ETD markets based on their specific needs such as customization, risk tolerance, and transparency. For example, a standard index option might be traded on an ETD, while a customized interest rate swap might be traded OTC.