Derivatives: Futures, Forwards, and Swaps
Derivatives: Futures, Forwards, and Swaps
💡 Key Takeaways
- Differentiate futures, forwards, and swaps, including trading venues (exchange vs OTC) and standardization.
- Understand how these contracts hedge price risk and how traders speculate on movements.
- Grasp basic pricing concepts: marking-to-market for futures and fixed vs floating legs in swaps.
- Identify key risks and settlements: margin requirements, counterparty risk, and cash vs physical settlement.
❓ Frequently Asked Questions
What is a derivative?
A financial instrument whose value comes from an underlying asset or rate (e.g., stocks, bonds, currencies, commodities, or interest rates).
What is a futures contract and how does it work?
A standardized agreement to buy or sell an asset at a set price on a future date, traded on an exchange. It uses margin and daily settlement (mark-to-market) and is used for hedging or speculation.
What is a forwards contract and how does it work?
A private, customized agreement to buy or sell an asset at a set price on a future date, traded over-the-counter (OTC). It carries counterparty risk and is often used to hedge specific needs.
What is a swap and what are common types?
A private agreement to exchange cash flows based on underlying rates or currencies. Common types include interest rate swaps (fixed vs. floating) and currency swaps (exchanging principal and interest in different currencies).
How do futures, forwards, and swaps differ?
Futures are standardized and exchange-traded with daily settlement; forwards are customized and OTC with settlement at maturity; swaps are private agreements exchanging cash flows. All are used to hedge risk or speculate on rates, prices, or currencies.