(financial derivatives) are those financial instruments derivatives of other, simpler financial instruments - stocks, bonds, foreign exchange, interest rate or real assets in the form of goods. Hence their name (English derivative - derivative). In essence, this financial risk trading tools tied to financial or real assets. After all, when trading derivatives, one actually buys and sells risks arising from a possible change in stock prices, exchange rate, interest rate and commodity prices. The nominal value of financial instruments circulating on the global derivatives market already exceeds $100 trillion, and the value of deals made on it is approaching $500 billion per year.
The main types of derivatives are:
The derivatives market is closely related to, primarily due to the fact that both of these markets are associated with the exchange of one currency for another or securities in one currency for securities in another currency. The main part of the derivatives market falls on currency futures and swaps (mostly short-term, although there are also long-term ones), as well as interest rate futures, options and swaps, which are based mainly on contracts for the exchange of various securities, more precisely, income from them.
In this market, operations are primarily represented by operations with swaps, futures and options. Futures is a standard transaction for the future purchase and sale of assets, which is concluded according to the rules established by the exchange. The futures market has a lot of liquidity, since the standard rules provide the possibility of free trading for an arbitrarily large number of participants.
If a futures contract is supplemented with a condition such as the right to choose for a certain fee (premium) to buy (sell) a security at a price predetermined in the contract or to refuse the transaction, then this additional parameter turns a futures transaction into an option (from the English option - choice).
At the same time, a person who bought a futures contract or an option on a futures contract to open a market position and did not liquidate this position by counter selling, takes, as stock exchange specialists usually say, a long position. Conversely, a person who has sold a futures contract or an option on a futures contract to open a market position and has not liquidated that position by counterpurchasing is short. In a more general alan, long and short positions refer to the entire stock market.
Thus, the considered transactions perform the function hedging, those. limiting risks when conducting various exchange operations.
Which, as they say, arise from other financial instruments, being their derivatives.
A derivative is an obligation to perform a certain action with respect to the so-called underlying asset (which in turn can be any other financial instrument or any commodity). For example, it may be an obligation to buy a certain amount of goods at a specified time at a certain price. Or an obligation to sell a certain number of shares after a certain period of time.
A derivative is a security with all the ensuing consequences. It can be bought and sold in the same way at a price that, although related to the price of the underlying asset, is far from always equal to it. As a rule, derivatives are used for risks on the corresponding underlying assets, or for purely speculative purposes.
Buyers of derivatives usually do not aim for the actual delivery of the underlying asset, but use them either as a tool to hedge their risks or to gain a price difference. Therefore, the amount of liabilities on derivatives may exceed the actual amount of the underlying asset.
Examples of underlying assets: stocks, interest rates, currencies, etc.
Examples of derivatives: options, futures, currency swaps, CFDs, etc.
We owe the first historically reliable information about the use of some analogues of modern derivatives to Ancient Babylon. It is known for certain that the Babylonian merchants, equipping their caravans on a long journey, concluded an agreement on the division of risk. Under this agreement, they received a loan with the condition of repayment in the event of successful delivery of goods. Naturally, the interest on this loan was significantly higher than the market average, but in this way the default option was covered (in case of loss of goods).
Babylonian merchants
The Middle Ages in Europe and Asia also bear evidence of the use of prototypes of today's derivatives. A document appeared at the fairs lettre de faire, which was, in fact, an obligation to deliver goods after a specific period (the predecessor of the modern forward contract). Also known are forward contracts for the supply of tulip bulbs during the period of the so-called tulip mania that swept Europe in the late 1630s.
Around the same time, rice coupons appeared in Japan, which were nothing more than an obligation to deliver a certain amount of rice at a given time. Japanese landowners exchanged these coupons with rice sellers for real money, which allowed them to fully prepare for the next harvest. And the sellers, in turn, provided themselves with a guaranteed stock for future trading.
And finally, the 19th century was marked by the emergence of derivatives in almost the same form that we are used to today. In 1830, PUT and CALL options were already in full swing on the London Stock Exchange. And in the US, the first futures contracts appeared in 1865, they were traded at the Chicago Board of Trade and were tied to the supply of grain.
Derivative financial instruments based on assets in the form of issued loans or debt securities (bonds, mortgages, bills, etc.) are commonly called credit derivatives. Mainly used by banks, their essence boils down to the fact that they make it possible to shift their credit risks on the shoulders of other investors, and in addition to significantly increase the liquidity of their assets.
Investors invest their money, of course, not to help the bank diversify its risks. They use credit derivatives to hedge their own risks and/or expect to profit from speculative transactions with them. The cost of such securities directly depends on changes in the base interest rate (see key interest rate).
Currently, the following types of credit derivatives are widely used:
Derivative(“derivative” from English. derivative”) is a derivative financial instrument from the underlying asset (main commodity). The underlying asset can be any product or service.
In other words, a derivative is a financial contract between parties that is based on the future value of the underlying asset. They have existed on the market since ancient times; derivatives for tulips, rice, etc. were concluded.
It turns out that the owner of the derivative enters into a contract for the purchase of the main product in the future, without having to think about warehousing and delivery. And this contract can already be speculated.
The purpose of concluding a contract is to make a profit by changing the price of an asset. The number of derivatives may exceed the number of assets. Derivatives are used for:
Renowned financier Warren Buffett called derivatives "a financial weapon of mass destruction" in 2002. Financial Analysts link the latest global financial crisis directly to market speculation. The value of derivatives significantly exceeded the value of underlying assets.
The most common derivatives:
Futures contracts(“future” from English.) future”) are agreements to buy/sell the underlying asset at a price agreed at the time the contract was entered into. The buying/selling itself takes place at a certain point in the future. Futures work only on exchanges, a standard contract is concluded.
Forward(“forward” from English.) forward”) is the OTC equivalent of a futures contract, which is a non-standard contract. The terms of the purchase / sale are determined only between the buyer and the seller.
Option(“choice” from English.) option”) grants the right to the buyer to carry out a purchase / sale transaction subject to the payment of a fee option to the seller. Under an option contract, the buyer has the right to fulfill his obligations. The seller is obliged to execute the transaction according to the agreed terms.
All contracts involve delivery of the underlying asset at a future date on the terms and conditions specified in the contract.
To understand what derivatives are, you can use the example of buying a car:
There are certain risks and rewards for both options. Risks.
Derivative financial instrument– a contract (agreement), the parties to which have the rights/obligations to perform actions regarding the underlying asset of the contract: buy/sell, accept/deliver. Other accepted names of derivative financial instruments (hereinafter referred to as derivatives): derivative securities, futures contracts/agreements or derivatives.
1. FEATURES OF PFI
1.1. Appeal
The main feature of PFI, which distinguishes it from other contracts for the sale of securities or other goods, is the possibility of free circulation (assignment). This is achieved by standardization/unification of the contract and exchange trading of derivatives.
The exception is the forward, the oldest futures contract, the ancestor of the entire modern line of derivatives. It is possible to sell (assign) forward rights or obligations only with the consent of the other party, which will require the conclusion of a separate agreement - an assignment agreement, in accordance with national or international law.
1.2. Deadlines
Another feature of PFIs is their urgency. Hence the name - fixed-term contract. The transfer of the underlying asset and (possibly) payment for it occurs at some specified date in the future or during a specified period. For futures and options, this is called the expiration date.
At the same time, the type, volume/quantity and price of the underlying asset are fixed on the date of conclusion of the contract.
1.3. Pricing
The derivative combines two values that are closely related to each other - the price of the underlying asset and, in fact, the price of a futures contract. Since exchange-traded derivatives can be traded, bought and sold as separate instruments, they have their own price dynamics, closely related to the dynamics of the value of the underlying asset. The price movement of a derivative and its underlying asset, in the general case, are not identical, as are the absolute values of such prices themselves.
However, there is some degree of correlation between them. For example, in options, the Black-Scholes model is widely used, according to which the value of an option is formed by the expected volatility (price volatility) of its underlying asset. The futures price on the expiration date is equal to the price (average price) of its underlying asset on that date.
1.4. Purposes of using derivatives
Buying (or selling) a derivative usually has two goals: hedging or speculation.
In the first case, the derivatives owner hedges the price of the underlying asset for future delivery. Thus, the buyer of currency under a forward contract fixes the dollar exchange rate against the ruble on the date of conclusion of the contract and insures himself against an increase in the dollar / ruble exchange rate.
The speculator profits from the price fluctuations of a futures contract, as well as any other instrument, security, currency, etc. When the PFI quotes rise, he opens long positions, and when it falls, he opens short ones.
There are more complex and subtle techniques that use a combination of urgent and spot instruments. An example is market-neutral spread trading strategies between a derivative and its underlying asset. A common pair is a stock index and an index futures. An index portfolio is used as a stock index - a portfolio of shares included in the index basket in the required proportions.
1.5. Correlation between the derivatives market and the underlying asset market
The volumes of the derivatives market and the underlying asset market do not match. The volume of futures, options, and forwards on Company A's shares is not at all equal to its market capitalization (the number of shares multiplied by their market value). It may be lower, but it may also be significantly higher.
It would seem that such a fact inevitably leads to the failure of the PFI implementation. This would indeed be the case with the obligation to deliver the underlying asset on the exercise of the derivative. In the event that the expiration of a futures contract does not require physical delivery, the obligations of the derivatives market participants are secured by the introduction of a guarantee.
2. UNDERLYING ASSET
Any commodities, securities, stock indices, currency, interest rates, as well as the derivatives themselves. For example, an option on a futures contract.
Modern practice also offers more exotic types of the underlying asset. Including, the inflation rate and other statistical data, meteorological parameters (temperature, wind force, etc.), physical, chemical and biological characteristics of the environment. In principle, the underlying asset can be any value that changes over time according to objective laws.
The key condition of a term contract (first of all, forward and futures) is whether the physical delivery of the underlying asset takes place. If yes, such a contract is defined as a delivery contract, otherwise, as a non-delivery or settlement contract. The result of the calculated PFI will be cash settlements between participants.
3. CLASSIFICATION OF PFI
In addition to the division into supply and settlement, fixed-term contracts can be systematized according to the following criteria.
3.1. Exchange and non-exchange derivatives
At the place of application.
A classic example of an off-exchange futures contract is a forward. A forward contract is a non-unified and non-standardized contract that is not an object of exchange trading.
Another thing is futures and options. These instruments, to an overwhelming extent, circulate only on the stock exchange and were created specifically for it.
3.2. Commodity and non-commodity derivatives
By type of underlying asset.
The oldest PFI-forward grew out of the needs of the traditional commodity market. Agricultural products, metals, energy carriers, everything that is directly related to the real sector of the economy, forms futures commodity contracts. Despite such content, they may well be of a calculated nature and act as hedging and speculation tools.
Derivatives of the financial segment have a non-commodity, financial "stuffing". Securities, currency ( currency pairs), interest rates, economic indicators, default insurance, stock indices and much more, as well as their various combinations.
4. MAIN TYPES OF PFI
4.1. Forward
Short name of a forward contract.
An agreement between the parties that provides for the delivery of the underlying asset in the future (for a delivery forward). The result of a non-deliverable forward will be cash settlements between the parties, based on the market price of the underlying asset on the date of execution of the forward contract.
The main advantage of the forward, which determined its popularity and gave impetus to the development of the entire range of futures instruments, is price fixing on the date of conclusion of the contract. Thus, the buyer under a forward contract is insured against an increase in the value of the underlying asset, while the seller is insured against its fall. The price of the underlying asset under a forward contract is called the forward price or the forward rate (for a currency forward).
Forward - non-exchange derivatives.
Not to be confused with a forward transaction on the exchange, namely, an exchange transaction with settlements from 3 days (T + 3)
The forward is predominantly commercial in nature. The underlying asset of the contract is determined by its type (certification) and the number of units (volume).
The forward is not standardized and is binding on both parties. Changing the terms of a forward contract, as well as the assignment of claims under it, is achieved with the consent of both parties.
4.2. Futures
Short name of the futures contract.
A standardized and unified form of a forward for exchange trading. Futures - exclusively exchange derivatives. Both settlement and supply contracts are circulated. Hedgers and speculators prefer settled (non-deliverable) futures.
Futures are more flexible derivatives in terms of the type of underlying asset. The widest range of commodity and non-commodity positions, from oil and gold to indices and interest rates.
In detail the main characteristics of the tool and general principles futures trading will be covered in a separate article of the derivatives category.
Here we restrict ourselves to a simple enumeration of the key parameters of the futures:
4.3. Option
An option contract (Latin optio - choice, desire, discretion) gives its owner the right to buy or sell the underlying asset at the price specified in the contract and on a certain date (within a certain period of time). The price mentioned is called the strike price, or strike price for short.
The buyer (owner) of the option may exercise his right, or may abstain. Everything depends on the market situation. The seller of the option (the person who issued the contract) is obliged to sell or buy the underlying asset at the request of the owner of the option contract.
The option has a value, the so-called premium. The buyer pays a premium when purchasing the contract, this is his expense. For the seller of the option, the premium is income.
An option is primarily an exchange instrument. The premium is his stock quote. There are also non-exchange non-standardized options. They resort to big players who are not satisfied with the proposed expiration dates for stock options. Outside the exchange, any expiration period is built into the option contract.
Globally, all options are classified according to two criteria:
1. Type of option.
An option to buy, a call option, a call option, or just a call. Gives the right to buy the underlying asset.
An option to sell, put option, put option or just put. Gives the right to sell the underlying asset.
2. Type of option.
The American option can be presented for exercise/redemption on any day before the deadline for its circulation.
The European option is exercised only on the date clearly specified in the option contract.
Options and the simplest option strategies will be discussed in more detail in the profile material of the derivatives category.
Currency swap, currency swap.
Two opposite conversion transactions for the same base amount with different value dates. For example, selling dollars for rubles with a buyback at a higher price. The buyback price is calculated based on the swap rate.
Interest rate swap, interest rate swap, IRS.
interest rate exchange derivatives. One party pays the other a fixed rate for base amount. The second party transfers to the first the income based on the floating rate for the same amount. So a fixed rate payment is changed to a floating rate payment.
Credit default swap, credit default swap, CDS.
Acts as insurance for the owner debt obligation(credit, bonds, bills). Upon the occurrence of certain events leading to the default of the debtor, the seller (issuer) of the CDS is obliged to repay the debt for him. The list of such events, called “credit events”, is specified in the terms of issuing a credit default swap. By analogy with an option, the CDS price is called its premium.
4.5. Contract for difference
It makes it possible to receive income from price fluctuations in the market of the underlying asset (securities, currency, other goods) without its acquisition.
A CFD market participant deposits the required margin (collateral) and opens long or short positions on the selected instrument. Profit/loss is accrued/debited from the trader's GI.
The CFD scheme has become the most widely used to attract domestic investors on international markets(stock and currency).
4.6. Warrant
From English warrant (warrant), warranty (guarantee).
A term contract that gives its holder the right to purchase securities (usually shares) at the price specified in the warrant. It is mainly used for underwriting, initial subscription for shares (IPO). It can be used as insurance or even a bonus to attract an investor.
For example, the price of shares in a warrant is set at par or even slightly lower. Issuers of securities (sellers of warrants) will reduce their possible losses at the expense of the price of the warrant. A kind of option to buy a block of shares.
In domestic legislation, the term “issuer option” that is close in meaning has been fixed (Federal Law “On the Securities Market” dated April 22, 1996 No. 39-FZ). At the same time, the legislator interprets the issuer's option as a security, not a PFI.
4.7. depositary receipt
Introduced to facilitate the entry of a foreign investor into the national stock markets. A depositary receipt (DR) is issued by a depository organization of the investor state, on whose account the shares of a foreign issuer are deposited. Thus, the owner of the DR has essential rights to the shares that are the subject of the DR without leaving its jurisdiction. The DR trend exactly repeats the trend of the paper itself, the owner of the DR will receive dividends when they are accrued.
Depending on the circulation markets, three types of AR appear in Russian sources:
According to the law 39-FZ, RDR has the status of a security (not derivatives).
5. SOME FACTS FROM THE HISTORY OF PFI
The prototypes of fixed-term contracts originated in Babylon several hundred years before our era.
Holland in the 1630s was swept by the legendary boom of tulip mania. The first documented crisis with signs of a financial bubble. Multimillion-dollar, in today's dollars and pounds, the turnover of flower bulbs on special tulip exchanges (collegia) would not have been possible without fixed-term contracts. "Tulip" futures and options were issued in the form of notarized guarantees. Actually, the main trading shaft was based on receipts, and not on bulbs. And the market crash of early 1637 was especially telling in options and futures.
Dynamics of the futures price index ( green color) and options (red)
on tulip bulbs in 1635-37.
In Japan in the middle of the 18th century, the role of exchange futures for rice was successfully performed by rice coupons. Trading in "rice" derivatives was brisk on the largest rice exchanges in the Land of the Rising Sun - Dojima in Osaka and Kuramae in Edo (modern Tokyo). The Japanese were so successful in the futures market that they became the founder of one of the popular methods of technical analysis - the construction and study of stock charts in the form of Japanese candlesticks. The authorship of candlestick analysis is attributed
The prices or conditions of which are based on the relevant parameters of another financial instrument, which will be the underlying one. Usually, the purpose of buying a derivative is not to obtain the underlying asset, but to profit from changes in its price. Distinctive feature derivatives in that their number does not necessarily match the number of the underlying instrument. Issuers of the underlying asset usually have nothing to do with issuing derivatives. For example, the total number of CFD contracts for shares of a company may be several times greater than the number of issued shares, while this itself joint-stock company does not issue or trade derivatives on its shares.
The derivative has the following characteristics:
Essentially, a derivative is an agreement between two parties under which they assume the obligation or the right to transfer a certain asset or amount of money on or before a specified date at an agreed price.
There are some other approaches to the definition of a derivative financial instrument. According to these definitions, the sign of urgency is optional - it is enough that this instrument is based on another financial instrument. There is also an approach according to which only one that is supposed to receive income from the difference in prices and is not expected to be used for the supply of goods or other underlying asset can be considered a derivative instrument.
Most derivative financial instruments in accordance with Russian legislation is not recognized as a security, as it is interpreted in federal law"About the securities market". The exception is an issuer option. However, there is such a term as derivative security. This concept includes instruments based on securities (forward contract for a bond, option for a share, depositary receipt).
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