There are four basic types of derivative instruments as we know. The most important differences are between options and the other three types of derivatives. Futures, forwards, and swaps each provide symmetric risk to a holder because the value of the derivative can change in both directions (gains or losses) without limits. This symmetric risk profile requires both counterparties to execute the contract whether the effect is favorable or unfavorable. In contrast, the holder of an option is not required or obligated to exercise the option and, in fact, will not do so if the option is at- or out-of-the-money.
This provides asymmetric risk for the holder who may want to avoid downside risk. Options also differ from the other derivative instruments described here in the requirement for an initial cash outlay, which represents the initial intrinsic and time values of the option.
An underlying, a notional amount, and the opportunity for net settlement characterize derivatives.
Major types of derivative instruments include forward contracts, futures contracts, options, and interest rate swaps.
Derivative instruments may be held as an investment and changes in their value should be recognized in current earnings. The value of a derivative is a function of the movement or changes in the underlying and the notional amount.
Major types of derivative instruments include forward contracts, futures contracts, options, and interest rate swaps.
Derivative instruments may be held as an investment and changes in their value should be recognized in current earnings. The value of a derivative is a function of the movement or changes in the underlying and the notional amount.