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Encyclopedia > Derivative (finance)
Derivatives traders at the Chicago Board of Trade.
Derivatives traders at the Chicago Board of Trade.

Derivatives are financial instruments whose value changes in response to the changes in underlying variables. The main types of derivatives are futures, forwards, options, and swaps. Chicago Board of Trade pit. ... Chicago Board of Trade pit. ... The Chicago Board of Trade (CBOT) NYSE: BOT, established in 1848, is the worlds oldest futures and options exchange. ... Financial instruments package financial capital in readily tradeable forms - they do not exist outside the context of the financial markets. ... In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ... A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. ... This article is about options traded in financial markets. ... For the Thoroughbred horse racing champion, see: Swaps (horse). ...


The main use of derivatives is to reduce risk for one party. The diverse range of potential underlying assets and pay-off alternatives leads to a huge range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) — see inflation derivatives — or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the pay-offs. For the Parker Brothers board game, see Risk (game) For other uses, see Risk (disambiguation). ... A contract is a legally binding exchange of promises or agreement between parties that the law will enforce. ... This article does not cite any references or sources. ... Ownership equity, commonly known simply as equity, also risk or liable capital, is a financial term for the difference between a companys assets and liabilities -- that is, the value that accrues to the owners (sole proprieter, partners, or shareholders). ... For other uses, see stock (disambiguation). ... For alternative meanings, see bond (a disambiguation page). ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... A comparison of three major stock indices: the NASDAQ Composite, Dow Jones Industrial Average, and S&P 500. ... It has been suggested that this article be split into multiple articles accessible from a disambiguation page. ... Inflation Derivatives or inflation-indexed derivatives refer to OTC and exchange traded derivatives that are used to transfer inflation risk from one counterparty to another. ...

Contents

Uses

Finance

US$100 bill The field of finance refers to the concepts of time, money and risk and how they are interelated. ... This is a file from the Wikimedia Commons, a repository of free content hosted by the Wikimedia Foundation. ...


Financial Markets

Bond market
Stock (Equities) Market
Forex market
Derivatives market
Commodity market
Spot (cash) Market
OTC market
Real Estate market This article does not cite any references or sources. ... The bond market, also known as the debit, credit, or fixed income market, is a financial market where participants buy and sell debt securities usually in the form of bonds. ... A stock market or (equity market) is a private or public market for the trading of company stock and derivatives of company stock at an agreed price; both of these are securities listed on a stock exchange as well as those only traded privately. ... In finance, the exchange rate between two currencies specifies how much one currency is worth in terms of the other. ... The derivatives markets are the financial markets for derivatives. ... Chicago Board of Trade Futures market Commodity markets are markets where raw or primary products are exchanged. ... Template:The Spot Market The Spot Market or Cash Marketis a commodities or securities market in which goods are sold for cash and delivered immediately. ... Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. ... Real estate is a legal term that encompasses land along with anything permanently affixed to the land, such as buildings. ...


Market Participants

Investors
Speculators
Institutional Investors There are two basic financial market participant catagories, Investor vs. ... Investment is a term with several closely related meanings in finance and economics. ... Speculation is the buying, holding, and selling of stocks, commodities, futures, currencies, collectibles, real estate, or any valuable thing to profit from fluctuations in its price as opposed to buying it for use or for income - dividends, rent etc. ... An institutional investor is an investor who is an institution like a bank, insurance fund, retirement fund, or mutual fund manager. ...


Corporate finance

Structured finance
Capital budgeting
Financial risk management
Mergers and Acquisitions
Accounting
Financial Statements
Auditing
Credit rating agency Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Structured finance describes any non-standard way of raising money. ... The process of determining which potential long-term projects are worth undertaking, by comparing their expected discounted cash flows with their internal rates of return. ... Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit and market risk. ... Acquisition redirects here. ... It has been suggested that Accounting scholarship be merged into this article or section. ... Historical financial statement Financial statements (or financial reports) are formal records of a business financial activities. ... Basic definition Audit is the examination of records and reports of a company, in order to check that what is provided is relevant and accurate. ... A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations. ...


Personal finance

Credit and Debt
Employment contract
Retirement
Financial planning Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. ... Credit as a financial term, used in such terms as credit card, refers to the granting of a loan and the creation of debt. ... For other uses, see Debt (disambiguation). ... An employment contract is an agreement entered into between an employer and an employee at the commencement of the period of employment and stating the exact nature of their business relationship, specifically what compensation the employee will receive in exchange for specific work performed. ... Retirement is the point where a person stops employment completely. ... A Financial Planner or Personal Financial Planner is a practicing professional who helps people to deal with various personal financial issues through proper planning, which includes but not limited to these major areas: tertiary education planning, retirement planning, investment planning, risk management and insurance planning, tax planning, estate planning and...


Public finance

Tax This article does not cite any references or sources. ... Taxes redirects here. ...


Banks and Banking

Fractional-reserve banking
Central Bank
List of banks
Deposits
Loan
Money supply For other uses, see Bank (disambiguation). ... Fractional-reserve banking refers to a financial system in which some fraction of the deposits can be used to finance profitable but illiquid investments. ... This article does not cite any references or sources. ... This is a list of banks throughout the world. ... Bank deposits are the large part of the money supply. They come in different types depending on withdrawal restrictions. ... For other uses, see Loan (disambiguation). ... In macroeconomics, money supply (monetary aggregates, money stock) is the quantity of currency and money in bank accounts in the hands of the non-bank public available within the economy to purchase goods, services, and securities. ...


Financial regulation

Finance designations
Accounting scandals Financial supervision is government supervision of financial institutions by regulators. ... There are a variety of Finance designations or Accreditations that can be earned, and awarded to those in the finance industry. ... Accounting scandals, or corporate accounting scandals are political and business scandals which arise with the disclosure of misdeeds by trusted executives of large public corporations. ...


History of finance

Stock market bubble
Recession
Stock market crash A stock market bubble is a type of economic bubble taking place in stock markets when price of stocks rise and become overvalued by any measure of stock valuation. ... In macroeconomics, a recession is a decline in a countrys real gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. ... A stock market crash is a sudden dramatic decline of stock prices across a significant cross-section of a stock market. ...


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Insurance and Hedging

One use of derivatives is as a tool to transfer risk by taking the opposite position in the For example, a wheat farmer and a wheat miller could enter into a futures contract to exchange cash for wheat in the future. Both parties have reduced the risk of the future: the uncertainty of the price and the availability of . For the Parker Brothers board game, see Risk (game) For other uses, see Risk (disambiguation). ... In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ...


Speculation and arbitrage

Speculators may trade with other speculators as well as with hedgers. In most financial derivatives markets, the value of speculative trading is far higher than the value of true hedge trading. As well as outright speculation, derivatives traders may also look for arbitrage opportunities between different derivatives on identical or closely related underlying securities. In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ...


In addition to directional plays (i.e. simply betting on the direction of the underlying security), speculators can use derivatives to place bets on the volatility of the underlying security. This technique is commonly used when speculating with traded options. Speculative trading in derivatives gained a great deal of notoriety in 1995 when Nick Leeson, a trader at Barings Bank, made poor and unauthorized investments in index futures. Through a combination of poor judgement on his part, lack of oversight by management, a naive regulatory environment and unfortunate outside events like the Kobe earthquake, Leeson incurred a $1.3 billion loss that bankrupted the centuries-old financial institution. Volatility most frequently refers to the standard deviation of the change in value of a financial instrument with a specific time horizon. ... Nicholas Leeson (English, born February 25, 1967) is a former derivatives trader whose unsupervised speculative trading caused the collapse of Barings Bank, the United Kingdoms oldest investment bank. ... Barings Bank (1762 to 1995) was the oldest merchant banking company in London, England [1] until its collapse in 1995 after one of the banks employees, Nick Leeson, lost $1. ... Categories: Japan-related stubs | 1995 | Earthquakes | Japanese history ... One thousand million (1,000,000,000) is the natural number following 999,999,999 and preceding 1,000,000,001. ...


Types of derivatives

OTC and exchange-traded

Broadly speaking there are two distinct groups of derivative contracts, which are distinguished by the way they are traded in market:

  • Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps, forward rate agreements, and exotic options are almost always traded in this way. The OTC derivatives market is huge. According to the Bank for International Settlements, the total outstanding notional amount is USD 516 trillion (as of June 2007)[1].
  • Exchange-traded derivatives (ETD) are those derivatives products that are traded via specialized derivatives exchanges or other exchanges. A derivatives exchange acts as an intermediary to all related transactions, and takes Initial margin from both sides of the trade to act as a guarantee. The world's largest[2] derivatives exchanges (by number of transactions) are the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of the 2007 merger of the Chicago Mercantile Exchange and the Chicago Board of Trade). According to BIS, the combined turnover in the world's derivatives exchanges totalled USD 344 trillion during Q4 2005. Some types of derivative instruments also may trade on traditional exchanges. For instance, hybrid instruments such as convertible bonds and/or convertible preferred may be listed on stock or bond exchanges. Also, warrants (or "rights") may be listed on equity exchanges. Performance Rights, Cash xPRTs(tm) and various other instruments that essentially consist of a complex set of options bundled into a simple package are routinely listed on equity exchanges. Like other derivatives, these publicly traded derivatives provide investors access to risk/reward and volatility characteristics that, while related to an underlying commodity, nonetheless are distinctive.

Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. ... For the Thoroughbred horse racing champion, see: Swaps (horse). ... This article needs to be cleaned up to conform to a higher standard of quality. ... In finance, an exotic option is a derivative which has features making it more complex than commonly traded products (vanilla options). ... BIS Headquarters in Basel The Bank for International Settlements (or BIS) is an international organization of central banks which exists to foster cooperation among central banks and other agencies in pursuit of monetary and financial stability. It carries out its work through subcommittees, the secretariats it hosts, and through its... Derivatives Exchange is an exchange for trading derivatives. ... Initial margin is the amount of cash collateral originally required by the clearing house and ones brokerage to be deposited by a party to contract, with a trader or exchange, to ensure against default. ... Korea Exchange (KRX) was created through the integration of the three existing Korean spot & futures exchanges (Korean Stock Exchange, Korean Futures Exchange & KOSDAQ) under the Korea Stock & Futures Exchange Act. ... The Korea Composite Stock Price Index (KOSPI) is an index of all companies traded on the Korea Stock Exchange. ... Eurex is a major futures and options exchange for European benchmark derivatives featuring open and low-cost electronic access globally. ... The Chicago Mercantile Exchange (CME or, simply, The Merc) (NYSE: CME) is an American financial exchange based in Chicago. ... President George W. Bush at the CME (March 6, 2001). ... The Chicago Board of Trade (CBOT) NYSE: BOT, established in 1848, is the worlds oldest futures and options exchange. ...

Common Derivative contract types

There are three major classes of derivatives:

  • Futures/Forwards, which are contracts to buy or sell an asset at a specified future date.
  • Optionals, which are contracts that give a holder the right to buy or sell an asset at a specified future date.
  • Swappings, where the two parties agree to exchange cash flows.

In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ... A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. ...

Examples

Some common examples of these derivatives are:

UNDERLYING CONTRACT TYPE
Exchange-traded futures Exchange-traded options OTC swap OTC forward OTC option
Equity Index DJIA Index future
NASDAQ Index future
Option on DJIA Index future
Option on NASDAQ Index future
Equity swap Back-to-back n/a
Money market Eurodollar future
Euribor future
Option on Eurodollar future
Option on Euribor future
Interest rate swap Forward rate agreement Interest rate cap and floor
Swaption
Basis swap
Bonds Bond future Option on Bond future n/a Repurchase agreement Bond option
Single Stocks Single-stock future Single-share option Equity swap Repurchase agreement Stock option
Warrant
Turbo warrant
Credit n/a n/a Credit default swap n/a Credit default option

Other examples of underlying exchangeables are: This page meets Wikipedias criteria for speedy deletion. ... Linear graph of the DJIA from 1901 until today Logarithmic graph of the DJIA from 1901 until today The Dow Jones Industrial Average (NYSE: DJI, also called the DJIA, Dow 30, or informally the Dow Jones or The Dow) is one of several stock market indices created by nineteenth-century... NASDAQ in Times Square, New York City. ... Linear graph of the DJIA from 1901 until today Logarithmic graph of the DJIA from 1901 until today The Dow Jones Industrial Average (NYSE: DJI, also called the DJIA, Dow 30, or informally the Dow Jones or The Dow) is one of several stock market indices created by nineteenth-century... NASDAQ in Times Square, New York City. ... An equity swap, a branch of derivative security, is a swap in which at least one party pays the return on a stock or stock index. ... This article is about short-term financing. ... An interest rate swap is a derivative in which one party exchanges a stream of interest payments for another partys stream of cash flows. ... This article needs to be cleaned up to conform to a higher standard of quality. ... // Interest rate cap An interest rate cap is a derivative in which the buyer receives money at the end of each period in which an interest rate exceeds the agreed strike price. ... To meet Wikipedias quality standards, this article or section may require cleanup. ... A basis swap is an interest rate swap which involves the exchange of two floating rate financial instruments denominated in the same currency. ... For alternative meanings, see bond (a disambiguation page). ... Repurchase agreements (RPs or Repos) are financial instruments used in the money markets and capital markets. ... A bond option is similar to a stock option with the difference that the underlying asset is a bond. ... For other uses, see Stock (disambiguation). ... Single-stock futures (SSFs) are securities that share some of the features of equities and also some of those of traditional commodity futures. ... An equity swap, a branch of derivative security, is a swap in which at least one party pays the return on a stock or stock index. ... Main article: Option A stock option is a specific type of option that uses the stock itself as an underlying instrument to determine the options pay-off (and therefore its value). ... For other uses of the term Warrant, see Warrant (disambiguation) In finance, a warrant is a security that entitles the holder to buy stock of the company that issued it at a specified price, which is much higher than the stock price at time of issue. ... The turbo warrant is a stock option with two new features. ... A credit default swap (CDS) is a bilateral contract under which two counterparties agree to isolate and separately trade the credit risk of at least one third-party reference entity. ... In finance, a default option or credit default option is a put option that makes a payoff in the event the issuer of a specified reference asset defaults. ...

Also known as energy trade, oil trade, gas trade, power trade. ... The word commodity has a different meaning in business than in Marxian political economy. ... A Freight derivative is a financial instrument for trading in future levels of freight rates, primarily for dry bulk carriers and tankers. ... Inflation Derivatives or inflation-indexed derivatives refer to OTC and exchange traded derivatives that are used to transfer inflation risk from one counterparty to another. ... Weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. ... A Credit Derivative is a contract to transfer the risk of the total return on a credit asset falling below an agreed level, without transfer of the underlying asset. ... // A property derivative is a derivative (finance) whose price and value derives from the value of a real estate asset, usually represented in the form of an index. ...

Portfolio

It should be understood that derivatives themselves are not to be considered investments since they are not an asset class. They simply derive their values from assets such as bonds, equities, currencies, etc. and are used to either hedge those assets or improve the returns on those assets.


Cash flow

The payments between the parties may be determined by:

  • the price of some other, independently traded asset in the future (e.g., a common stock);
  • the level of an independently determined index (e.g., a stock market index or heating-degree-days);
  • the occurrence of some well-specified event (e.g., a company defaulting);
  • an interest rate;
  • an exchange rate;
  • or some other factor.

Some derivatives are the right to buy or sell the underlying security or commodity at some point in the future for a predetermined price. If the price of the underlying security or commodity moves into the right direction, the owner of the derivative makes money; otherwise, they lose money or the derivative becomes worthless. Depending on the terms of the contract, the potential gain or loss on a derivative can be much higher than if they had traded the underlying security or commodity directly. Common stock, also referred to as common shares, are, as the name implies, the most usual and commonly held form of stock in a corporation. ... In finance, default occurs when a debtor has not met its legal obligations according to the debt contract, e. ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ...


Valuation

Total world derivatives from 1998-2007 compared to total world wealth in the year 2000

Market and arbitrage-free prices

Two common measures of value are:

  • Market price, i.e. the price at which traders are willing to buy or sell the contract
  • Arbitrage-free price, meaning that no risk-free profits can be made by trading in these contracts; see rational pricing

Market price is an economic concept with commonplace familiarity; it is the price that a good or service is offered at, or will fetch, in the marketplace; it is of interest mainly in the study of microeconomics. ... In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ... Rational pricing is the assumption in financial economics that asset prices (and hence asset pricing models) will reflect the arbitrage-free price of the asset as any deviation from this price will be arbitraged away. This assumption is useful in pricing fixed income securities, particularly bonds, and is fundamental to...

Determining the market price

For exchange-traded derivatives, market price is usually transparent (often published in real time by the exchange, based on all the current bids and offers placed on that particular contract at any one time). Complications can arise with OTC or floor-traded contracts though, as trading is handled manually, making it difficult to automatically broadcast prices. In particular with OTC contracts, there is no central exchange to collate and disseminate prices.


Determining the arbitrage-free price

The arbitrage-free price for a derivatives contract is complex, and there are many different variables to consider. Arbitrage-free pricing is a central topic of financial mathematics. The stochastic process of the price of the underlying asset is often crucial. A key equation for the theoretical valuation of options is the Black-Scholes formula, which is based on the assumption that the cash flows from a European stock option can be replicated by a continuous buying and selling strategy using only the stock. A simplified version of this valuation technique is the binomial options model. Mathematical finance is the branch of applied mathematics concerned with the financial markets. ... In the mathematics of probability, a stochastic process is a random function. ... Option contracts are complex to value. ... The Black-Scholes model, often simply called Black-Scholes, is a model of the varying price over time of financial instruments, and in particular stocks. ... This article is about options traded in financial markets. ... In finance, the binomial options model provides a generalisable numerical method for the valuation of options. ...


Controversy

Derivatives are often subject to the following criticisms:

  • The use of derivatives can result in large losses due to the use of leverage. Derivatives allow investors to earn large returns from small movements in the underlying asset's price. However, investors could lose large amounts if the price of the underlying moves against them significantly. There have been several instances of massive losses in derivative markets, including:
  • The Nick Leeson affair in 1994.
  • The bankruptcy of Orange County, CA in 1994, the largest municipal bankruptcy in U.S. history. On December 6, 1994, Orange County declared Chapter 9 bankruptcy, from which it emerged in June 1995. The county lost about $1.6 billion through derivatives trading. Orange County was neither bankrupt nor insolvent at the time; however, because of the strategy the county employed it was unable to generate the cash flows needed to maintain services. Orange County is a good example of what happens when derivatives are used incorrectly and positions liquidated in an unplanned manner; had they not liquidated they would not have lost any money as their positions rebounded.
  • The bankruptcy of Long-Term Capital Management in 2000.
  • The loss of $6.4 billion in the failed fund Amaranth Advisors, which was long natural gas in September 2006 when the price plummeted.
  • The loss of $7.2 Billion by Société Générale in January 2008 through mis-use of futures contracts.
  • Derivatives (especially swaps) expose investors to counter-party risk. For example, suppose a person wanting a fixed interest rate loan for his business, but finding that banks only offer variable rates, swaps payments with another business who wants a variable rate, synthetically creating a fixed rate for the person. However if the second business goes bankrupt, it can't pay its variable rate and so the first business will lose its fixed rate and will be paying a variable rate again. If interest rates have increased, it is possible that the first business may be adversely affected, because it may not be prepared to pay the higher variable rate. This chain reaction effect worries certain economists[citation needed], who posit that since many derivative contracts are so new, the effect could lead to a large disaster. Different types of derivatives have different levels of risk for this effect. For example, standardized stock options by law require the party at risk to have a certain amount deposited with the exchange, showing that they can pay for any losses; Banks who help businesses swap variable for fixed rates on loans may do credit checks on both parties. However in private agreements between two companies, for example, there may not be benchmarks for performing due diligence and risk analysis. This has been a cause for concern among many economists[citation needed].
  • Derivatives pose unsuitably high amounts of risk for small or inexperienced investors. Because derivatives offer the possibility of large rewards, they offer an attraction even to individual investors. However, speculation in derivatives often assumes a great deal of risk, requiring commensurate experience and market knowledge, especially for the small investor, a reason why some financial planners advise against the use of these instruments. Derivatives are complex instruments devised as a form of insurance, to transfer risk among parties based on their willingness to assume additional risk, or hedge against it.
  • Derivatives typically have a large notional value. As such, there is the danger that their use could result in losses that the investor would be unable to compensate for. The possibility that this could lead to a chain reaction ensuing in an economic crisis, has been pointed out by legendary investor Warren Buffett in Berkshire Hathaway's annual report. Buffet stated that he regarded them as 'financial weapons of mass destruction'. The problem with derivatives is that they control an increasingly larger notional amount of assets and this may lead to distortions in the real capital and equities markets. Investors begin to look at the derivatives markets to make a decision to buy or sell securities and so what was originally meant to be a market to transfer risk now becomes a leading indicator. Many economists[citation needed] are worried that derivatives may cause an economic crisis at some point in the future.
  • Derivatives massively leverage the debt in an economy, making it ever more difficult for the underlying real economy to service its debt obligations and curtailing real economic activity, which can cause a recession or even depression. In the view of Marriner S. Eccles, U.S. Federal Reserve Chairman from November, 1934 to February, 1948, too high a level of debt was one of the primary causes of the 1920s-30s Great Depression.

Nevertheless, the use of derivatives has its benefits: Nicholas Leeson (English, born February 25, 1967) is a former derivatives trader whose unsupervised speculative trading caused the collapse of Barings Bank, the United Kingdoms oldest investment bank. ... Orange County, California is a major region in the Greater Los Angeles Area of Southern California. ... Notice of closure stuck on the door of a computer store the day after its parent company, Granville Technology Group Ltd, declared bankruptcy (strictly, put into administration—see text) in the United Kingdom. ... Long Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether (the former vice-chairman and head of bond trading at Salomon Brothers). ... Amaranth Advisors LLC was an American multistrategy hedge fund managing US$9 billion in assets. ... Société Générale (Euronext: GLE) is one of the main European financial services companies and also maintains extensive activities in others parts of the world. ... Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. ... Warren Edward Buffett (born August 30, 1930, in Omaha, Nebraska) is an American investor, businessman and philanthropist. ... For the Xzibit album, see Weapons of Mass Destruction (album). ... Marriner Stoddard Eccles (1890 - 1977) was a U.S. banker and economist. ... The Chairman of the Board of Governors of the United States Federal Reserve is the head of the central bank of the United States and one of the more important decision-makers in American economic policies. ... For other uses, see The Great Depression (disambiguation). ...

  • Derivatives facilitate the buying and selling of risk, and thus have a positive impact on the economic system[citation needed]. Although someone loses money while someone else gains money with a derivative, under normal circumstances, trading in derivatives should not adversely affect the economic system because it is not zero sum in utility.
  • Former Federal Reserve Board chairman Alan Greenspan commented in 2003 that he believed that the use of derivatives has softened the impact of the economic downturn at the beginning of the 21st century.[citation needed]

An economic system is a particular set of social institutions which deals with the production, distribution and consumption of goods and services in a particular society. ... Zero-sum describes a situation in which a participants gain (or loss) is exactly balanced by the losses (or gains) of the other participant(s). ... For other uses, see Utility (disambiguation). ... The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central bank of the United States. ... Squalltoonix (born March 6, 1926 in New York City) is an American economist and was Chairman of the Board of Governors of the Federal Reserve of the United States from 1987 to 2006. ... A recession is usually defined in macroeconomics as a fall of a countrys Gross National Product in two successive quarters. ...

Definitions

  • Bilateral Netting: A legally enforceable arrangement between a bank and a counter-party that creates a single legal obligation covering all included individual contracts. This means that a bank’s obligation, in the event of the default or insolvency of one of the parties, would be the net sum of all positive and negative fair values of contracts included in the bilateral netting arrangement.
  • Credit derivative: A contract that transfers credit risk from a protection buyer to a credit protection seller. Credit derivative products can take many forms, such as credit default options, credit limited notes and total return swaps.
  • Derivative: A financial contract whose value is derived from the performance of assets, interest rates, currency exchange rates, or indexes. Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards and various combinations thereof.
  • Gross negative fair value: The sum of the fair values of contracts where the bank owes money to its counter-parties, without taking into account netting. This represents the maximum losses the bank’s counter-parties would incur if the bank defaults and there is no netting of contracts, and no bank collateral was held by the counter-parties.
  • Gross positive fair value: The sum total of the fair values of contracts where the bank is owed money by its counter-parties, without taking into account netting. This represents the maximum losses a bank could incur if all its counter-parties default and there is no netting of contracts, and the bank holds no counter-party collateral.
  • High-risk mortgage securities: Securities where the price or expected average life is highly sensitive to interest rate changes, as determined by the FFIEC policy statement on high-risk mortgage securities.
  • Notional amount: The nominal or face amount that is used to calculate payments made on swaps and other risk management products. This amount generally does not change hands and is thus referred to as notional.
  • Over-the-counter (OTC) derivative contracts : Privately negotiated derivative contracts that are transacted off organized futures exchanges.
  • Structured notes: Non-mortgage-backed debt securities, whose cash flow characteristics depend on one or more indices and/or have embedded forwards or options.
  • Total risk-based capital: The sum of tier 1 plus tier 2 capital. Tier 1 capital consists of common shareholders equity, perpetual preferred shareholders equity with non-cumulative dividends, retained earnings, and minority interests in the equity accounts of consolidated subsidiaries. Tier 2 capital consists of subordinated debt, intermediate-term preferred stock, cumulative and long-term preferred stock, and a portion of a bank’s allowance for loan and lease losses.

The introduction to this article provides insufficient context for those unfamiliar with the subject matter. ... // A credit derivative is a financial instrument or derivative (finance) whose price and value derives from the creditworthiness of the obligations of a third party, which is isolated and traded. ... Credit risk is the risk of loss due to a debtors non-payment of a loan or other line of credit (either the principal or interest (coupon) or both). ... In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ... This article is about options traded in financial markets. ... The introduction to this article provides insufficient context for those unfamiliar with the subject matter. ... FFIEC stands for Federal Financial Institutions Examination Council ... Nominal or notional amounts outstanding are defined as the gross nominal or notional value of all deals concluded and not yet settled on the reporting date. ... Face value is the value of a coin or paper money, as printed on the coin or bill itself by the minting authority. ... Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. ... Tier 1 capital is the core measure of a banks financial strength from a regulators point of view. ... Tier 2 capital is a measure of a banks financial strength with regard to the second most reliable form of financial capital, from a regulators point of view. ... In accounting, retained earnings refers to the portion of net income from a period which is retained by the corporation, rather than distributed to its owners. ... Minority interest in business is an accounting concept that refers to ownership of a company that is less than 50% of outstanding shares. ... A loan or security that, in the case of default, would only be paid out after other, more senior loans were paid in full. ... Preferred stock, also called preferred shares or preference shares, is typically a higher ranking stock than voting shares, and its terms are negotiated between the corporation and the investor. ...

Footnotes

  1. ^ BIS survey: The Bank for International Settlements (BIS), in their semi-annual OTC derivatives market activity report from November 2007 that, at the end of June 2007, the total notional amounts outstanding of OTC derivatives was $516 trillion with a gross market value of $11 trillion. See also OTC derivatives markets activity in the second half of 2004.)
  2. ^ Futures and Options Week: According to figures published in F&O Week 10 October 2005. See also FOW Website.

BIS Headquarters in Basel The Bank for International Settlements (or BIS) is an international organization of central banks which exists to foster cooperation among central banks and other agencies in pursuit of monetary and financial stability. It carries out its work through subcommittees, the secretariats it hosts, and through its... Nominal or notional amounts outstanding are defined as the gross nominal or notional value of all deals concluded and not yet settled on the reporting date. ... is the 283rd day of the year (284th in leap years) in the Gregorian calendar. ... Year 2005 (MMV) was a common year starting on Saturday (link displays full calendar) of the Gregorian calendar. ...

See also

In finance, a foreign exchange option (commonly shortened to just fx option) is a derivative security where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at pre-agreed exchange rate on a specified date. ... To meet Wikipedias quality standards, this article may require cleanup. ...

External links


  Results from FactBites:
 
Derivative - Wikistock (2399 words)
A derivative is a generic term for specific types of investments from which payoffs over time are derived from the performance of assets (such as commodities, shares or bonds), interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) or an index of weather conditions).
Other uses of derivatives are to gain an economic exposure to an underlying security in situations where direct ownership of the underlying is too costly or is prohibited by legal or regulatory restrictions, or to create a synthetic short position.
One should keep in mind that one purpose of derivatives is as a form of insurance, to move risk from someone who cannot afford a major loss to someone who could absorb the loss, or is able to hedge against the risk by buying some other derivative.
Derivative (finance) - Wikipedia, the free encyclopedia (2259 words)
A derivative is a generic term for specific types of investments from which payoffs over time are derived from the performance of assets (such as commodities, shares or bonds), interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) or an index of weather conditions).
Other uses of derivatives are to gain an economic exposure to an underlying security in situations where direct ownership of the underlying is too costly or is prohibited by legal or regulatory restrictions, or to create a synthetic short position.
One should keep in mind that one purpose of derivatives is as a form of insurance, to move risk from someone who cannot afford a major loss to someone who could absorb the loss, or is able to hedge against the risk by buying some other derivative.
  More results at FactBites »

 
 

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