Types of Financial Derivatives
Bryan A Robert
Bryan Hoo and Robert Samuel are active authors as well as Professional Investors in different financial markets and they founded Bryan&Robert Publishing as their flagship publishing company.
This is the complete lesson notes on the topic "Types of Financial Derivatives".
Okay, it is lesson time again. We will talk about the topic about "Types of Financial Derivatives". Enjoy~??
What Are Derivatives?
A derivative is a financial instrument that derives its value from something else. The value of a derivative is linked to the value of the underlying asset. In simpler terms, think of putting down a bet on a hand of blackjack as the underlying and then someone else making a bet on the success of your blackjack hand as a derivative of the underlying.
Types of Derivatives
There are generally considered to be 4 types of derivatives: forward, futures, swaps, and options.
Derivative#1: Options
An options contract gives the buyer the right, but not the obligation, to buy or sell something at a specific price on or before a specific date. With a forward contract, the buyer and seller are obligated to make the transaction on the specified date, whereas with options, the buyer has the choice to execute their option and buy the asset at the specified price.
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Derivative#2: Forward Contract
A forward contract is where a buyer agrees to purchase the underlying asset from the seller at a specific price on a specific date. Forward contracts are more customizable than futures contracts and can be tailored to a specific commodity, amount, and date.
Derivative#3: Swaps
A swap is an agreement to exchange future cash flows. Typically, one cash flow is variable while the other is fixed. Say for example a bank holds a mortgage on a house with a variable rate but no longer wants to be exposed to interest rate fluctuations, they could swap that mortgage with someone else’s fixed-rate mortgage so they lock in a certain rate.
CDS, or credit default swap, is a financial derivative that "swaps" (or trades) risk of default on debt. It is insurance on default of a credit instrument, like a bond. If you're a buyer of a CDS contract, you are "betting" that a credit instrument will default. If it does default, the buyer would be made whole.
Alright, that is all from today lesson. More and more interesting topics will be discussed in the near future. Stay Tune~??
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