This document provides an overview of the derivative market. It defines derivatives and discusses their origins and functions, including hedging risk, speculating, and arbitrage. The main types of markets and derivative products are described, including forwards and futures, options, warrants, swaps, and contracts for differences. Trends in over-the-counter derivative markets are presented, such as the dominance of forex derivatives and increasing regulations. The document concludes that derivatives play a key role in financial markets globally and their use is expected to continue growing.

1. KASSI Florian
International Financial Markets and institutions
May 2021
Presentation of the
Derivative market

2. Table of content
Introduction………………………………………….……….p.1
1. Functions……………………………………….………...p.2
2. Types of markets………………………….…………..p.3
3. Types of derivatives…………………………….……p.4
3.1. Forward and futures………………………………p.4
3.2. Options…………………………………………….…p.5
3.3. Warrants……………………………………....……..p.6
3.4. Swaps………………………………………………...p.7
3.5. Contract For Differences (CFD).......................p.8
4. Trends in the OTC markets……………………....p.9
Conclusion……………………………………...…………….p.11
References…………………………………..........................p.12

3. Definition
- a derivative security is an instrument whose existence and value is contingent upon the existence of
another instrument or security
- a bilateral contract
Origins
- the Chicago Board of Trade (created in 1848, commodity exchange) enabled in 1865, the
development of spot and forward trading
Vanilla or Exotic derivatives
- Vanilla: basic
- Exotic: complex, adapted to some specific needs
Introduction
1

4. • Hedging: reducing a risk
- exchange rate
- Raw materials prices
- liquidity
- correlation of a portfolio
• Speculating: using leverage to take risky position in order to maximize profit
- focusing on short-term market value changes
- betting on the drop of an asset price by intensively short-selling
• Undertaking arbitrage: taking advantage of a situation without taking risk
- gap in the valuation of a same security in two different markets
1. Functions
2

5. Organized markets
- Exchange Traded Derivatives (ETD)
- standardized
- clearing house: intermediary
2. Types of markets
37 47 57 69 79
58 73 68 58 54 70
197
259
299
418
586 598 604 601
648 633
693
0
100
200
300
400
500
600
700
800
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Value
in
trillion
U.S.
dollars
Notional value on international derivatives market 2003-2013 by trading type
Exchange traded Over-the-counter
Over The counter (OTC) markets
- “tailor-made” products
- bilateral agreements without
intermediary
3

6. Definition
- agreement between two parties according to which one party
will buy the underlying asset at the expiry for a specified price
Forward vs Future
- same purpose
- Forwards are traded in OTC markets
- Futures are traded in organized markets
3. Types of derivative
3.1. Forward and future
where S is the price of the asset at expiry,
and K is the delivery price.
Note: long’s point of view
4

7. Definition
- agreement between two parties according to which one party has the right to buy or
sell an underlying asset to the other party, at the expiry for a specified price,
Call vs Put (options)
- Call options = a right to buy
- Put options = a right to sell
Long vs Short (positions)
- Long position = buying, owning
- Short position = selling, owing
3.2. Options
3. Types of derivatives products
Short put return Short call return
Long call return
Long put return
5

8. Definition
- same purpose as options, but the regular one is issued by a
company with its stock or a bond as the underlying asset
- later expiry date than options
- more valuable in volatile markets
3.3. Warrants
3. Types of derivatives products
Warrant-linked bond
- warrant issued jointly with a company’s bond
- detachable or wedded
Covered warrant
- listed and issued by a financial institution
- the underlying asset can be of any type (currency,
commodity, basket of assets, index)
6

9. Definition
- agreement between two parties to exchange the cash flows or
liabilities from two different financial instruments.
- OTC
- cash flows based on notional value
- the principal is not usually exchanged
Currency swap
- exchange of an equivalent amount of money in two different
currencies
3.4. Swaps
3. Types of derivatives products
Currency swap involving only interest
7

10. Definition
- contract between two parties where the buyer must pay the seller (broker) the
difference between the current value of an asset and its value at contract time.
- bet on the market price movement of the asset
- no delivery of the asset
- OTC
3.5. Contract for differences (CFD)
3. Types of derivatives products
Long vs Short (positions)
- Long CFD: betting on the increase of the asset’s price
- Short CFD: betting on the decrease of the asset’s price
CFD regulations per country
8

11. 4. Trends in OTC markets
- Forex derivatives are dominating the market, followed by interest rate derivatives
- Equity derivatives are increasingly popular, especially supported by the US market,
- Credit derivatives have almost constantly decreased on the whole period,
- Commodity derivatives stay anecdotic according to this indicator
Comparison of the products by market value
9

12. 4. Trends in OTC markets
Strengthened regulations…
- European Market Infrastructure Regulation (EMIR) enforced in 2016
→ OTC derivative transactions have to be cleared using a central counterparty
- Higher capital requirements
…which made the costs increase, but didn’t prevent
the overall market to grow since 2019
- 15,5 trillion USD market value in H1 2020
10

13. Conclusion
• Wide array of derivatives products
• Deeply part of the trades worldwide
• Lowered risk and enhanced liquidity
• However, some positions still represent a potential important
risk of loss
We can expect derivatives uses to grow in the future, in a financial
world governed by risk limitation
11

14. - Derivative Instruments: A Guide to Theory and Practice, Eales, Brian ; Choudhry, Moorad ; Choudhry,
Mr Moorad; Oxford: Elsevier Science & Technology; 2003
- Derivative Securities and Difference Methods; You-lan Zhu, Xiaonan Wu, I-Liang Chern, Zhi-zhong
Sun; Springer Finance; 20013
- The Changing Shape of Derivatives Markets, Eurex – Bloomberg media; 2019
- www.Investopedia.com
- www.statista.com
- https://www.bis.org/publ/otc_hy2105.htm
12
References