financial derivatives 101

what are the financial derivatives?

basically it’s a contract which price is based on price of another financial asset

example of a derivative

company A buys a derivative form bank B by which
B will pay 1 million euros if Ibex 35 index is bigger than 20000 points in one year’s time (this on is called digital call option)

Types of derivatives

there’re derivatives which can be bought in organized markets , like stock exchanges , and there are other type which are negotiated in private
OTC derivatives (over the counter)

also, derivatives could be classified by underlying security:

interest rate derivatives

example: dirivatives whose payout depends on level of Euribor , for example swaps

FX derivatives

example: payout depens on EURUSD exchange rate

Equity derivatives

example: payout depends on Santander stock price

credit derivatives

example: A pays B 1 million if company C goes broke

commodity derivatives

A pays B difference between precio del crudo Brent crude price and Ural crude price

another way to classify them is by exercise type:

american exercise

option can be exercised at any date before maturity

european exercise

option can be executed only at maturity

bermudan exercise

option can be executed at various time points

derivatives markets

OTC derivatives market is huge: total outstanding notion at the end of 2011 was 10 time bigger than world GDP (700 trillion $)