Category: Derivatives

Contract for difference (CFD)

In finance, a contract for difference (CFD) is a contract between two parties, typically described as “buyer” and “seller”, stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time (if the difference is negative, then the buyer pays instead to the seller). In effect CFDs are financial derivatives that allow traders to take advantage of prices moving up (long positions) or prices moving down (short positions) on underlying financial instruments and are often used to speculate on those markets.

For example, when applied to equities, such a contract is an equity derivative that allows traders to speculate on share price movements, without the need for ownership of the underlying shares.

ISDA

The International Swaps and Derivatives Association (ISDA) is a trade organization of participants in the market for over-the-counter derivatives. It is headquartered in New York City, and has created a standardized contract (the ISDA Master Agreement) to enter into derivatives transactions. In addition to legal and policy activities, ISDA manages FpML (Financial products Markup Language), an XML message standard for the OTC Derivatives industry. ISDA has more than 820 members in 57 countries; its membership consists of derivatives dealers, service providers and end users.

Warrants

In finance, a warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed price called exercise price until the expiry date. Warrants and options are similar in that the two contractual financial instruments allow the holder special rights to buy securities. Both are discretionary and have expiration dates. The word warrant simply means to “endow with the right”, which is only slightly different from the meaning of option.

Vanilla options

In finance, an option is a contract which gives the buyer (the owner or holder of the option) the right, but not the obligation, to buy or sell an underlying asset or instrument at a specific strike price on a specified date, depending on the form of the option. The strike price may be set by reference to the spot price (market price) of the underlying security or commodity on the day an option is taken out, or it may be fixed at a discount in a premium. The seller has the corresponding obligation to fulfill the transaction—to sell or buy—if the buyer (owner) “exercises” the option. An option that conveys to the owner the right to buy at a specific price is referred to as a call; an option that conveys the right of the owner to sell at a specific price is referred to as a put. Both are commonly used in and by the old traded, but the call option is more frequently discussed.

Forward contract

In finance, a forward contract or simply a forward is a non-standardized contract between two communities to buy or to sell an asset at a specified time at a price agreed upon today, making it a type of derivative instrument. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position.

Futures contract

In finance, a futures contract (more colloquially, futures) is a standardized forward contract, a legal agreement to buy or sell something at a predetermined price at a specified time in the future. The asset transacted is usually a commodity or financial instrument and the transaction is usually done on the trading floor of a futures exchange. The predetermined price the parties agree to buy and sell the asset for is known as the forward price. The specified time in the future — which is when delivery and payment occur — is known as the delivery date. Because it is a function of an underlying asset, a futures contract is a derivative product.

Swap

A swap is a derivative in which two counterparties exchange cash flows of one party’s financial instrument for those of the other party’s financial instrument. The benefits in question depend on the type of financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in question can be the periodic interest (coupon) payments associated with such bonds. Specifically, two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are accrued and calculated. Usually at the time when the contract is initiated, at least one of these series of cash flows is determined by an uncertain variable such as a floating interest rate, foreign exchange rate, equity price, or commodity price.