A derivative instrument is a
financial contract whose payoff structure is determined by the value of the
underlying asset. The underlying asset can be commodity, security, interest
rate, share price index, oil price, currency (exchange rate) in circulation,
precious metals or the like
Types of derivatives:
contract obliges its purchaser to buy a given amount of a specified asset at
some stated time in the future at the forward price
contracts are created and traded on organized futures exchanges. . Buyers and
sellers of future contracts do not deal directly with each other but with a
An option is
a derivative security that gives the buyer (holder) the right, but not the
obligation, to buy or sell a specified quantity of a specified asset within a
specified time period
A swap is a
derivative contract through which two parties exchange financial instruments.The two commonly used swaps are interest rate swaps and
instruments in US
system of the United States of America (US) constitutes the banking system1 ,
nonbank financial institutions2 and financial markets3 The US Congress
introduces legislation relating to financial services, and regulators at federal
and state levels issue rules and regulations governing the practices of the
shares that represent part ownership of a business enterprise. There are
different types of equities, namely, stocks, preferred stocks and warrants.
equities markets comprise several stock exchanges. The most important are
located in New York City: the New York Stock Exchange (NYSE) and the American
Stock Exchange (AMEX). Stocks not listed on a formal exchange are traded in the
over-the-counter (OTC) market which includes the National Association of
Securities Dealers Automated Quotation system (Nasdaq) and the National Market
system (NMS). Securities markets are regulated by the Securities and Exchange
Bonds are debt securities with maturities of longer than one year and must be
registered with the SEC. The Securities and Exchange Commission (SEC) protects
investors and maintains the integrity of the securities markets. Bonds may be issued by governments or by
private sector companies.
Asset-backed securities are divided into two
categories, namely, mortgage-backed securities and non-mortgage securities
Mortgage-backed securities give investors the right to interest payments from a
large number of mortgage loans. Examples of mortgage-backed securities are
Fannie Maes: 0 Fannie Maes are securities issued by the Federal National
Mortgage Association, a publicly owned, federally sponsored corporation that
provides liquidity to the financial system by buying mortgages from the
institutions that originate them, thus allowing them to relend the funds
, Ginnie Maes:
Ginnie Maes are securities issued by mortgage bankers, under the auspices of
the Government National Mortgage Association, to facilitate government mortgage
Macs: 2 Freddie Macs are issued by the Federal Home Loan Mortgage Corporation
(FHLMC). FHLMC packages the individual mortgages they buy into pools (groups of
similar types of mortgages with similar rates and maturities) and sell them to
investors as debt securities
and Farmer Macs: 3 Farmer Macs are
pass-throughs of mortgages on farms and rural homes. The Federal Agricultural
Mortgage Credit Corporation, a shareholder-owned company established by the US
government, securitizes both agricultural mortgages and loans guaranteed by the
US Department of Agriculture, some of which are not mortgages.
Non-mortgage securities are asset backed securities which give owners the right
to income from other assets. Examples of non-mortgage securities are credit
card securities, home equity loans, automotive loans, manufactured-housing
securities, student loans, stranded-cost securities and other novel types of
asset-backed securities. There is no government regulator or SRO to regulate
the asset-backed securities industry.
Securities 5.13 Municipal securities are debt securities such as bonds and
notes issued by states, cities and counties or their agencies to help financing
public projects. Municipal securities are regulated by the Municipal Securities
Rulemaking Board (MSRB).
These are debt
instruments with maturities of one year or less and provide liquidity for
investors to obtain or lend funds on a short-term basis. These instruments
commercial paper: short-term debt obligation
of a private-sector firm or a governmentsponsored corporation.
bankers’ acceptances: Bankers’ acceptances are promissory notes
issued by a non-financial firm to bank for a loan.
treasury bills: T-bills, are securities issued
by national governments with a maturity of one year or less. 27. 28. 30 government
agency notes: Government agency notes are short-term debt notes issued by
national government agencies or government-sponsored corporations
local government notes: Local government notes
are short-term debt notes issued by state, provincial or local governments or
by agencies of these governments
interbank loans: Interbank loans are loans extended from one
bank to another with which it has no affiliation.
time deposits Time deposits are
interest-bearing bank deposits that cannot be withdrawn without penalty before
a specified date. They are also called certificates of deposit (CDS)
international agency paper.
t is an agreement to buy or sell
a standard amount of a specific commodity in the future at a certain price.
There are two forms of future contracts, namely, commodity futures and
financial futures Commodity futures concern agricultural products, metals,
energy and transport. Financial futures include interest-rate futures, currency
futures, stock-index futures, share-price futures, etc.
Options are contracts that give
the holder the right, but not the obligation to either buy or sell a stipulated
commodity at a specified price on or before the expiration date. The most
widely traded types of options are equity options, index options, interest-rate
options, commodity options and currency options.
The Commodity Futures Trading
Commission (CFTC) is an independent agency with the mandate to regulate
commodity futures and option markets in the US.