Agreement to exchange an asset in the future at a price set today. Buyer and seller must perform, or buy back the contract and reverse their position. Traded OTC; non-standardized; illiquid; subject to credit risk.
Same as a forward contract, except traded on an organized exchange; standardized; liquid; no credit risk.
An agreement to exchange at a predetermined price, within a set time. The option buyer (holder) has the OPTION to exercise the option or not. Trade on organized exchanges – liquid market, little/no credit risk.
Markets don’t really know the extent of damage these derivatives will do (or have done) to the banking and financial system; they don’t understand how the bailout plan will effect these swaps and it is trying to digest these complex factors.
Markets really hate uncertainty and not knowing what’s going to happen.
More risk greater return demanded
Higher return demanded lower prices paid
Markets are rationally reacting to extreme degree of uncertainty; although perhaps over-reacting – also a common market trait.
But, what goes down also comes back up… just sit tight and hold steady as the information gets digested and risk finds its proper price!