Today's List - Derivatives

Today I'll take a look at some terms which fall under the 'Derivatives Market'. I'd tried reading up on this in July, during the placement season (Torux!) and don't remember much of it now.

Derivatives are financial instruments (or contracts) which are derived from the value of an underlying, which can be an asset, an index or another derivative. The main types of derivatives: Forwards (Futures), Options and Swaps.

Forward contract is an agreement between two parties to buy or sell an asset at a specified time in future. Forwards are traded over-the-counter.

Futures are similar to forwards, but differ in two ways -

• Futures are standardised and are traded on an exchange
• Futures are margined, with significantly less credit risk

Option is a contract written by the seller which gives the buyer a right, but not an obligation, to buy (call option) or to sell (put option) a particular asset. The seller receives a premium in return for granting the option.

Swap is a derivative in which two counterparties agree to exchange one stream of cash flows against another stream - these streams are called the legs of the swap.

The Derivatives market is divided into two - a market for exchange traded derivatives (futures) and a market for over-the-counter derivatives.