A1.7. Derivatives

A derivative is a security or contract, the value of which is derived from or tied to the value of an underlying asset or security. It is not an asset class in itself, because it has no independent value. Derivative instruments are available for equities, stock indexes, currencies, commodities, interest rates, and many other types of assets.

Some types of derivatives are common, straightforward, and widely traded on derivative exchanges. Such derivatives are often referred to as “vanilla.” Other derivatives are uncommon, specialized, complex, and potentially laborious to price and structure; these derivatives are known as “exotics” and are usually traded over the counter.

There are four main categories of derivatives:

1. A futures contract is an agreement to buy or sell a specific amount of a commodity or security at a specific price on a specific date in the future. If the price goes up in the interim, the buyer make