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Basics of Financial Derivatives

In: Fundamentals of Institutional Asset Management

Author

Listed:
  • Frank J. Fabozzi
  • Francesco A. Fabozzi

Abstract

Derivative instruments, or simply derivatives, are contracts that essentially derive their value from the behavior of cash market instruments such as stocks, stock indexes, bonds, currencies, and commodities that underlie the contract. There are three general categories of derivatives: (1) futures and forwards, (2) options, and (3) swaps. Derivatives are either traded on an exchange or in the over-the-counter (OTC) market. That is, there are exchange-traded derivatives and OTC derivatives. Exchange-traded derivatives are standardized contracts. An advantage of OTC derivatives over exchange-traded derivatives is that they offer asset managers customized solutions for their investment strategy. In fact, one of the keys to the success of OTC derivatives is the flexibility of the payoff structures that can be created. A key difference between exchange-traded and OTC derivatives is that the former are guaranteed by the exchange, while the latter are the obligation of the non-exchange entity that is the counterparty. Thus, the user of an OTC derivative is subject to credit risk or counterparty risk…

Suggested Citation

  • Frank J. Fabozzi & Francesco A. Fabozzi, 2020. "Basics of Financial Derivatives," World Scientific Book Chapters, in: Fundamentals of Institutional Asset Management, chapter 6, pages 143-168, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789811221590_0006
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    Keywords

    Investment Risks; Investment Vehicles; Portfolio Theory; Asset Pricing Theory; Mean-Variance Analysis; Measuring Return; Measuring Risk; Company Equity Analysis; Equity Valuation Models; Common Stock Alpha Strategies; Common Stock Beta Strategies; Smart Beta Strategies; Factor Investing; Equity Indexing; Equity Derivatives; Bond Analytics; Bond Pricing; Interest Rate Risk; Duration; Interest Rate Derivatives; Credit Derivatives; Multi-Asset Portfolio Strategies; Collective Investment Vehicles; Alternative Assets;
    All these keywords.

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G1 - Financial Economics - - General Financial Markets

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