Derivatives: Overview

What is a A derivative is a financial instrument representing a contract between two

derivative? parties. The characteristics and value of a derivative depend on the
characteristics and value of an underlying asset.

Common underlying assets in derivative contracts include equities, debt

instruments, commodities, currencies, interest rates, and market indexes.

Derivative Derivatives may be categorized as exchange-traded derivatives (EXT) or

categories over-the-counter derivatives (OTC.)

EXT derivatives OTC derivatives

Have standardized terms and Do not have standard terms and are
conditions (e.g. delivery terms, customized contracts negotiable
size, etc.) between two parties

Have a trading platform and May lack a uniform system for

clearing association at the trading and clearing1
exchange Exposure to counterparty risk
Reduction of counterparty
risk

Have increased liquidity, price Have lower liquidity, calculated

transparency, and minimal risk prices, and increased counterparty
risk

Are accessible to retail Are conducted almost entirely

customers (e.g. via futures between institutions on a principal-
commission merchants, etc.) to-principal basis

Have a high level of regulation Have limited regulation2

Derivative There are several different types of derivatives; common examples are listed
types below.
Most futures and options are exchange-traded derivatives3
Swaps (e.g. interest rate swaps and credit default swaps), currency forwards,
and swaptions are examples of over-the-counter derivatives.

1
Some swaps have central clearing capabilities
2
The OTC market faces increased regulation, particularly with respect to central clearing
3
Some options are OTC instruments.