Editing Derivative (finance) (section)

==Types==<!-- This section is linked from [[Financial instrument]] -->
In broad terms, there are two groups of derivative contracts, which are distinguished by the way they are traded in the market:

===Over-the-counter derivatives===
[[Over-the-counter (finance)|Over-the-counter]] (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as [[swap (finance)|swaps]], [[forward rate agreement]]s, [[exotic option]]s – and other [[exotic derivative]]s – are almost always traded in this way. The OTC derivative market is the largest market for derivatives, and is largely unregulated with respect to disclosure of information between the parties, since the OTC market is made up of banks and other highly sophisticated parties, such as [[hedge fund]]s. Reporting of OTC amounts is difficult because trades can occur in private, without activity being visible on any exchanges

According to the [[Bank for International Settlements]], who first surveyed OTC derivatives in 1995,<ref name=BIS2007>{{cite report |author1=Ryan Stever |author2=Christian Upper |author3=Goetz von Peter |title= BIS Quarterly Review |publisher=Bank for International Settlements |date=December 2007 |url=http://www.bis.org/publ/qtrpdf/r_qt0712.pdf }}</ref> reported that the "[[gross market value]], which represent the cost of replacing all open contracts at the prevailing market prices,&nbsp;... increased by 74% since 2004, to $11 trillion at the end of June 2007 (BIS 2007:24)."<ref name="BIS2007" /> [[Position (finance)|Positions]] in the OTC derivatives market increased to $516 trillion at the end of June 2007, 135% higher than the level recorded in 2004. The total outstanding notional amount is US$708 trillion (as of June 2011).<ref name="afgh">BIS survey: The [[Bank for International Settlements]] (BIS) semi-annual [http://www.bis.org/publ/otc_hy1111.pdf OTC derivatives market report], for end of June 2008, showed US$683.7 trillion total [[Notional amount|notional amounts]] outstanding of OTC derivatives with a [[gross market value]] of US$20 trillion. ''See also [http://www.bis.org/publ/otc_hy1111.htm Prior Period Regular OTC Derivatives Market Statistics]''.</ref> Of this total notional amount, 67% are [[interest rate derivative|interest rate contracts]], 8% are [[Credit default swap|credit default swaps (CDS)]], 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other. Because OTC derivatives are not traded on an exchange, there is no central counter-party. Therefore, they are subject to [[Credit risk#Counterparty risk|counterparty risk]], like an ordinary [[contract]], since each counter-party relies on the other to perform.

===Exchange-traded derivatives===
[[Exchange-traded derivative contract|Exchange-traded derivatives]] (ETD) are those derivatives instruments that are traded via specialized [[derivatives exchange]]s or other exchanges. A derivatives exchange is a market where individuals trade standardized contracts that have been defined by the exchange.<ref name="hull" /> A derivatives exchange acts as an intermediary to all related transactions, and takes [[initial margin]] from both sides of the trade to act as a guarantee. The world's largest<ref name="foweek">''Futures and Options Week'': According to figures published in F&O Week October 10, 2005. See also [http://www.fow.com FOW Website].</ref> derivatives exchanges (by number of transactions) are the [[Korea Exchange]] (which lists [[KOSPI]] Index Futures & Options), [[Eurex]] (which lists a wide range of European products such as interest rate & index products), and [[CME Group]] (made up of the 2007 merger of the [[Chicago Mercantile Exchange]] and the [[Chicago Board of Trade]] and the 2008 acquisition of the [[New York Mercantile Exchange]]). According to BIS, the combined turnover in the world's derivatives exchanges totaled US$344 trillion during Q4 2005. By December 2007 the [[Bank for International Settlements]] reported<ref name="BIS2007" /> that "derivatives traded on exchanges surged 27% to a record $681 trillion."<ref name="BIS2007"/>{{rp|22}}

===Inverse ETFs and leveraged ETFs===
{{Main|Exchange-traded fund}}
[[Inverse exchange-traded fund|Inverse exchange-traded funds (IETFs)]] and [[Exchange-traded fund#Leveraged ETFs|leveraged exchange-traded funds (LETFs)]]<ref>{{Cite web|url=https://www.investopedia.com/ask/answers/102815/are-etfs-considered-derivatives.asp|title=Are ETFs Considered Derivatives?|last=Morris|first=Jason|website=Investopedia|language=en|access-date=2020-03-23}}</ref> are two special types of exchange traded funds (ETFs) that are available to common traders and investors on major exchanges like the NYSE and Nasdaq. To maintain these products' [[net asset value]], these funds' administrators must employ more sophisticated [[financial engineering]] methods than what's usually required for maintenance of traditional ETFs. These instruments must also be regularly [[Rebalancing|rebalanced]] and re-indexed each day.

===Common derivative contract===
Some of the common variants of derivative contracts are as follows:
# [[Forward contract|Forwards]]: tailored contract between two parties, where payment takes place at a specific time in the future at today's pre-determined price.
# [[Futures contract|Futures]]: contracts to buy or sell an asset on a future date at a price specified today. A futures contract differs from a forward contract in that the futures contract is a standardized contract written by a [[clearing house (finance)|clearing house]] that operates an exchange where the contract can be bought and sold; the forward contract is a non-standardized contract written by the parties themselves.
# [[Option (finance)|Options]]: contracts that give the owner the right, but not the obligation, to buy (in the case of a [[call option]]) or sell (in the case of a [[put option]]) an asset. The price at which the sale takes place is known as the [[strike price]], and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. In the case of a [[European option]], the owner has the right to require the sale to take place on (but not before) the maturity date; in the case of an [[American option]], the owner can require the sale to take place at any time up to the maturity date. If the owner of the contract exercises this right, the counter-party has the obligation to carry out the transaction. Options are of two types: [[call option]] and [[put option]].
# [[Binary option]]s: contracts that provide the owner with an all-or-nothing profit profile.
# [[Warrant (finance)|Warrants]]: apart from the commonly used short-dated options which have a maximum maturity period of one year, there exist certain long-dated options as well, known as [[Warrant (finance)|warrants]]. These are generally traded over the counter.
# [[Swap (finance)|Swaps]]: contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies exchange rates, bonds/interest rates, [[commodities exchange]], stocks or other assets.
::Swaps can basically be categorized into [[Interest rate swap]] and [[Currency swap]].<ref>{{cite web|title=Financial Markets: A Beginner's Module|url=http://www.nseindia.com/education/content/module_ncfm.htm|access-date=October 12, 2011|archive-date=August 30, 2011|archive-url=https://web.archive.org/web/20110830112932/http://nseindia.com/education/content/module_ncfm.htm|url-status=dead}}</ref>
Some common examples of these derivatives are the following:

{| class="wikitable"
|-
! rowspan="2" |UNDERLYING
! colspan="5" |CONTRACT TYPES
|-
! Exchange-traded futures
! Exchange-traded options
! OTC swap
! OTC forward
! OTC option
|-
! Equity
| [[Dow Jones Industrial Average|DJIA]] Index future <br /> [[Single-stock futures|Single-stock future]]
| Option on [[Dow Jones Industrial Average|DJIA]] Index future <br /> Single-share option
| [[Equity swap]]
| Back-to-back <br /> [[Repurchase agreement]]
| [[Stock option]]<br />[[Warrant (finance)|Warrant]]<br />[[Turbo warrant]]
|-
! Interest rate
| Eurodollar future <br /> Euribor future
| Option on Eurodollar future <br /> Option on Euribor future
| [[Interest rate swap]]
| [[Forward rate agreement]]
| [[Interest rate cap and floor]] <br /> [[Swaption]] <br /> [[Basis swap]] <br /> [[Bond option]]
|-
! Credit
| Bond future
| Option on Bond future
| [[Credit default swap]] <br /> [[Total return swap]]
| [[Repurchase agreement]]
| [[Credit default option]]
|-
! Foreign exchange
| [[Currency future]]
| Option on currency future
| [[Currency swap]]
| [[Currency forward]]
| [[Currency option]]
|-
! Commodity
| [[West Texas Intermediate|WTI]] crude oil futures
| [[Weather derivative]]
| [[Commodity swap]]
| Iron ore forward contract
| [[Gold as an investment#Derivatives, CFDs and spread betting|Gold option]]
|}

===Collateralized debt obligation===
A '''[[collateralized debt obligation]]''' ([[Collateralized debt obligation|CDO]]) is a type of [[structured finance|structured]] [[asset-backed security|asset-backed security (ABS)]]. An "asset-backed security" is used as an umbrella term for a type of security backed by a pool of assets{{snd}}including collateralized debt obligations and [[Mortgage-backed security|mortgage-backed securities (MBS)]] (Example: "The capital market in which asset-backed securities are issued and traded is composed of three main categories: ABS, MBS and CDOs".<ref>{{cite web|last=Vink|first=Dennis| title=ABS, MBS and CDO compared: An empirical analysis|url= http://mpra.ub.uni-muenchen.de/10381/2/MPRA_paper_10381.pdf| work=August 2007 |publisher=Munich Personal RePEc Archive|access-date=July 13, 2013}}</ref>){{snd}}and sometimes for a particular type of that security{{snd}}one backed by consumer loans (example: "As a rule of thumb, securitization issues backed by mortgages are called MBS, and securitization issues backed by debt obligations are called CDO, [and] [[Securitization]] issues backed by consumer-backed products{{snd}}car loans, consumer loans and credit cards, among others{{snd}}are called ABS.) <ref>{{cite web|last=Vink|first=Dennis|title=ABS, MBS and CDO compared: An empirical analysis|url=http://mpra.ub.uni-muenchen.de/10381/2/MPRA_paper_10381.pdf|work=August 2007|publisher=Munich Personal RePEc Archive|access-date=July 13, 2013}}; see also {{cite web|title=What are Asset-Backed Securities?|url=http://www.investinginbonds.com/learnmore.asp?catid=5&subcatid=16&id=10#sthash.roSaSia3.dpuf|publisher=SIFMA|access-date=July 13, 2013|quote=Asset-backed securities, called ABS, are bonds or notes backed by financial assets. Typically these assets consist of receivables other than mortgage loans, such as credit card receivables, auto loans, manufactured-housing contracts and home-equity loans.|archive-date=June 29, 2018|archive-url=https://web.archive.org/web/20180629101514/http://www.investinginbonds.com/learnmore.asp?catid=5&subcatid=16&id=10#sthash.roSaSia3.dpuf|url-status=dead}})</ref> Originally developed for the corporate debt markets, over time CDOs evolved to encompass the mortgage and mortgage-backed security (MBS) markets.<ref name="Lemke 2013">Lemke, Lins and Picard, ''Mortgage-Backed Securities'', §5:15 (Thomson West, 2014).</ref>

Like other private-label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. The CDO is "sliced" into [[tranche|"tranches"]], which "catch" the cash flow of interest and principal payments in sequence based on seniority.<ref>{{cite journal| last1=Koehler| first1=Christian| title=The Relationship between the Complexity of Financial Derivatives and Systemic Risk |journal=Working Paper| pages=17|ssrn= 2511541| date=May 31, 2011}}</ref> If some loans default and the cash collected by the CDO is insufficient to pay all of its investors, those in the lowest, most "junior" tranches suffer losses first. The last to lose payment from default are the safest, most senior tranches. Consequently, [[coupon (bond)|coupon]] payments (and interest rates) vary by tranche with the safest/most senior tranches paying the lowest and the lowest tranches paying the highest rates to compensate for higher [[default risk]]. As an example, a CDO might issue the following tranches in order of safeness: Senior AAA (sometimes known as "super senior"); Junior AAA; AA; A; BBB; Residual.<ref name="Lemke 2014">Lemke, Lins and Smith, ''Regulation of Investment Companies'' (Matthew Bender, 2014 ed.).</ref>

Separate [[Special-purpose entity|special-purpose entities]]{{snd}}rather than the parent [[investment bank]]{{snd}}issue the CDOs and pay interest to investors. As CDOs developed, some sponsors repackaged tranches into yet another iteration called "[[CDO-Squared]]" or the "CDOs of CDOs".<ref name="Lemke 2014"/> 
In the early 2000s, CDOs were generally diversified,<ref>Bethany McLean and [[Joe Nocera]], ''All the Devils Are Here, the Hidden History of the Financial Crisis'', Portfolio, Penguin, 2010, p. 120</ref> but by 2006–2007{{snd}}when the CDO market grew to hundreds of billions of dollars{{snd}}this changed. CDO collateral became dominated not by loans, but by lower level ([[Credit ratings#Corporate credit ratings|BBB or A]]) tranches recycled from other asset-backed securities, whose assets were usually non-prime mortgages.<ref name="FCIR-p127">[http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf "Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States"], a.k.a. "The Financial Crisis Inquiry Report", p. 127</ref> These CDOs have been called "the engine that powered the mortgage supply chain" for nonprime mortgages,<ref name="FCIR-130">''The Financial Crisis Inquiry Report'', 2011, p. 130</ref> and are credited with giving lenders greater incentive to make non-prime loans<ref name="FCIR-133">''The Financial Crisis Inquiry Report'', 2011, p. 133</ref> leading up to the 2007–09 [[subprime mortgage crisis]].

===Credit default swap===
A [[Credit default swap|'''credit default swap''' ('''CDS''')]] is a [[Swap (finance)|financial swap]] agreement that the seller of the CDS will compensate the buyer (the creditor of the reference loan) in the event of a loan [[Default (finance)|default]] (by the debtor) or other [[credit event]]. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults. It was invented by [[Blythe Masters]] from [[J.P. Morgan & Co.|JP Morgan]] in 1994.
In the event of default the buyer of the CDS receives compensation (usually the [[face value]] of the loan), and the seller of the CDS takes possession of the defaulted loan. However, anyone with sufficient collateral to trade with a bank or hedge fund can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct [[insurable interest]] in the loan (these are called "naked" CDSs). If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a [[Credit default swap#Auctions|credit event auction]]; the payment received is usually substantially less than the face value of the loan.<ref>{{cite news |url=http://ftalphaville.ft.com/blog/2012/01/05/779501/why-do-they-exist |title=Credit event auctions: Why do they exist? |work= FT Alphaville |author = Lisa Pollack |date=January 5, 2012 }}</ref>
Credit default swaps have existed since the early 1990s, and increased in use after 2003. By the end of 2007, the outstanding CDS amount was $62.2&nbsp;trillion,<ref name='ISDA Annual Chart'>{{cite web |url=http://www.isda.org/statistics/pdf/ISDA-Market-Survey-annual-data.pdf |title=Chart; ISDA Market Survey; Notional amounts outstanding at year-end, all surveyed contracts, 1987–present |access-date=April 8, 2010 |publisher=[[International Swaps and Derivatives Association]] (ISDA) |archive-url=https://web.archive.org/web/20120307124122/http://www.isda.org/statistics/pdf/ISDA-Market-Survey-annual-data.pdf |archive-date=March 7, 2012 |url-status=dead  }}</ref> falling to $26.3&nbsp;trillion by mid-year 2010<ref name="test">[http://www.isda.org/statistics/recent.html "ISDA 2010 Mid-Year Market Survey"] {{Webarchive|url=https://web.archive.org/web/20110913153054/http://www.isda.org/statistics/recent.html |date=September 13, 2011 }}. Latest available a/o March 1, 2012.</ref> but reportedly $25.5<ref>{{cite web |url=http://www.isdacdsmarketplace.com/market_statistics |title=ISDA: CDS Marketplace |publisher=Isdacdsmarketplace.com |date=December 31, 2010 |access-date=March 12, 2012 |archive-date=January 19, 2012 |archive-url=https://web.archive.org/web/20120119141741/http://www.isdacdsmarketplace.com/market_statistics |url-status=dead }}</ref>&nbsp;trillion in early 2012. CDSs are not traded on an exchange and there is no required reporting of transactions to a government agency.<ref name="IMF254">{{cite journal |title=Credit Derivatives: Systemic Risks and Policy Options |journal= IMF Working Papers |date=November 2009|first=John |last=Kiff |author2=Jennifer Elliott |author3=Elias Kazarian |author4=Jodi Scarlata |author5 =Carolyne Spackman  |volume= 09|issue=WP/09/254 |pages= 1|doi= 10.5089/9781451874006.001 |doi-broken-date= February 25, 2025 |s2cid= 167560306 |url= http://www.imf.org/external/pubs/ft/wp/2009/wp09254.pdf |access-date=April 25, 2010 }}</ref> During the [[2008 financial crisis]], the lack of transparency in this large market became a concern to regulators as it could pose a [[systemic risk]].<ref name='Deutsche Bank Report'>{{cite journal|title=Credit default swaps: Heading towards a more stable system|journal=Deutsche Bank Research: Current Issues|date=December 21, 2009|author1=Christian Weistroffer|author2=Deutsche Bank Research|url=http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000252032.pdf|access-date=April 15, 2010|archive-date=February 2, 2010|archive-url=https://web.archive.org/web/20100202200136/http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000252032.pdf|url-status=dead}}</ref>

<ref name='Sirri Testimony'>{{cite news | url= https://www.sec.gov/news/testimony/2008/ts101508ers.htm |title= Testimony Concerning Credit Default Swaps Before the House Committee on Agriculture October 15, 2008 |access-date=April 2, 2010 |first=Erik |last=Sirri}}</ref><ref name='Partnoy Article'>{{cite journal |title= The Promise And Perils of Credit Derivatives |journal= University of Cincinnati Law Review |year=2007 | author1 = Frank Partnoy |author2 =David A. Skeel, Jr. |volume=75 |pages=1019–1051 |ssrn=929747|author1-link= Frank Partnoy }}</ref> In March 2010, the [DTCC] Trade Information Warehouse announced it would give regulators greater access to its credit default swaps database.<ref>{{cite news |url=http://www.dtcc.com/news/press/releases/2010/data_release_policy.php |title=Media Statement: DTCC Policy for Releasing CDS Data to Global Regulators |access-date=April 22, 2010 |date=March 23, 2010 |work=Depository Trust & Clearing Corporation |url-status=dead |archive-url=https://web.archive.org/web/20100429154058/http://www.dtcc.com/news/press/releases/2010/data_release_policy.php |archive-date=April 29, 2010  }}</ref>
CDS data can be used by [[financial risk management|financial professionals]], regulators, and the media to monitor how the market views [[credit risk]] of any entity on which a CDS is available, which can be compared to that provided by [[Credit rating agency|credit rating agencies]]. U.S. courts may soon be following suit.
Most CDSs are documented using standard forms drafted by the [[International Swaps and Derivatives Association]] (ISDA), although there are many variants.<ref name="Deutsche Bank Report"/> In addition to the basic, single-name swaps, there are [[basket (finance)|basket]] default swaps (BDSs), index CDSs, funded CDSs (also called [[credit-linked note]]s), as well as loan-only credit default swaps (LCDS). In addition to corporations and governments, the reference entity can include a [[special-purpose vehicle]] issuing [[Asset-backed security|asset-backed securities]].<ref name='Mengle Overview'>{{cite journal |title= Credit Derivatives: An Overview |journal= Economic Review (FRB Atlanta) |date= 2007 |first= David |last= Mengle |volume= 92 |issue= 4 |url= http://www.frbatlanta.org/filelegacydocs/erq407_mengle.pdf |access-date= April 2, 2010 |archive-url= https://web.archive.org/web/20101214063532/http://www.frbatlanta.org/filelegacydocs/erq407_mengle.pdf |archive-date= December 14, 2010 |url-status= dead }}</ref>
Some claim that derivatives such as CDS are potentially dangerous in that they combine priority in bankruptcy with a lack of transparency. A CDS can be unsecured (without collateral) and be at higher risk for a default.

===Forwards===
In finance, a '''forward contract''' or simply a '''forward''' is a non-standardized contract between two parties to buy or to sell an asset at a specified future time at an amount agreed upon today, making it a type of derivative instrument.<ref name="hull">{{cite book|first1=John C. |last1=Hull |title=Options, Futures and another Derivatives |edition=6th |publisher=Prentice Hall |location=New Jersey |year=2006 |isbn=978-0131499089}}</ref><ref>[http://chicagofed.org/webpages/publications/understanding_derivatives/index.cfm "Understanding Derivatives: Markets and Infrastructure"], [[Federal Reserve Bank of Chicago]]</ref> This is in contrast to a [[spot contract]], which is an agreement to buy or sell an asset on its spot date, which may vary depending on the instrument, for example most of the FX contracts have Spot Date two business days from today. 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]]. The price agreed upon is called the [[delivery price]], which is equal to the [[forward price]] at the time the contract is entered into.
The price of the underlying instrument, in whatever form, is paid before control of the instrument changes. This is one of the many forms of buy/sell orders where the time and date of trade is not the same as the [[value date]] where the [[Security (finance)|securities]] themselves are exchanged.

The [[forward price]] of such a contract is commonly contrasted with the [[spot price]], which is the price at which the asset changes hands on the [[spot date]]. The difference between the spot and the forward price is the [[forward premium]] or forward discount, generally considered in the form of a [[Profit (accounting)|profit]], or loss, by the purchasing party. Forwards, like other derivative securities, can be used to [[Hedge (finance)|hedge]] risk (typically currency or exchange rate risk), as a means of [[speculation]], or to allow a party to take advantage of a quality of the underlying instrument which is time-sensitive.

A closely related contract is a [[futures contract]]; they [[Futures contract#Futures versus forwards|differ in certain respects]]. Forward contracts are very similar to futures contracts, except they are not exchange-traded, or defined on standardized assets.<ref>[https://www.wikinvest.com/Forward_Contract Forward Contract on Wikinvest]{{Dead link|date=September 2024 |bot=InternetArchiveBot |fix-attempted=yes }}</ref> Forwards also typically have no interim partial settlements or "true-ups" in margin requirements like futures{{snd}}such that the parties do not exchange additional property securing the party at gain and the entire unrealized gain or loss builds up while the contract is open. However, being traded [[Over-the-counter (finance)|over the counter]] ([[Over-the-counter (finance)|OTC]]), forward contracts specification can be customized and may include mark-to-market and daily margin calls. Hence, a forward contract arrangement might call for the loss party to pledge collateral or additional collateral to better secure the party at gain.{{Clarify|date=November 2009}} In other words, the terms of the forward contract will determine the collateral calls based upon certain "trigger" events relevant to a particular counterparty such as among other things, credit ratings, value of assets under management or redemptions over a specific time frame (e.g., quarterly, annually).

===Futures===
In [[finance]], a 'futures contract' (more colloquially, '''futures''') is a standardized [[contract]] between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the ''futures price'') with delivery and payment occurring at a specified future date, the ''delivery date'', making it a derivative product (i.e. a financial product that is derived from an underlying asset). The contracts are negotiated at a [[futures exchange]], which acts as an intermediary between buyer and seller. The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, is said to be "[[Long (finance)|long]]", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be "[[Short (finance)|short]]".

While the futures contract specifies a trade taking place in the future, the purpose of the futures exchange is to act as intermediary and mitigate the risk of default by either party in the intervening period. For this reason, the futures exchange requires both parties to put up an initial amount of cash (performance bond), the [[Futures contract#Margin|margin]]. Margins, sometimes set as a percentage of the value of the futures contract, need to be proportionally maintained at all times during the life of the contract to underpin this mitigation because the price of the contract will vary in keeping with supply and demand and will change daily and thus one party or the other will theoretically be making or losing money. To mitigate risk and the possibility of default by either party, the product is marked to market on a daily basis whereby the difference between the prior agreed-upon price and the actual daily futures price is settled on a daily basis. This is sometimes known as the variation margin where the futures exchange will draw money out of the losing party's margin account and put it into the other party's thus ensuring that the correct daily loss or profit is reflected in the respective account. If the margin account goes below a certain value set by the Exchange, then a margin call is made and the account owner must replenish the margin account. This process is known as "marking to market". Thus on the delivery date, the amount exchanged is not the specified price on the contract but the [[spot price|spot value]] (i.e., the original value agreed upon, since any gain or loss has already been previously settled by marking to market). Upon marketing the strike price is often reached and creates much income for the "caller".

A closely related contract is a [[forward contract]]. A forward is like a futures in that it specifies the exchange of goods for a specified price at a specified future date. However, a forward is not traded on an exchange and thus does not have the interim partial payments due to marking to market. Nor is the contract standardized, as on the exchange.
Unlike an [[option (finance)|option]], both parties of a futures contract must fulfill the contract on the delivery date. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures [[position (finance)|position]] can close out its contract obligations by taking the opposite position on another futures contract on the same asset and settlement date. The difference in futures prices is then a profit or loss.

===Mortgage-backed securities===
A [[Mortgage-backed security|'''mortgage-backed security''' ('''MBS''')]] is an [[asset-backed security]] that is secured by a [[mortgage]], or more commonly a collection ("pool") of sometimes hundreds of [[mortgage loan|mortgages]]. The mortgages are sold to a group of individuals (a government agency or investment bank) that "[[securitization|securitizes]]", or packages, the loans together into a security that can be sold to investors. The mortgages of an MBS may be [[Residential mortgage-backed security|residential]] or [[Commercial mortgage-backed security|commercial]], depending on whether it is an Agency MBS or a Non-Agency MBS; in the United States they may be issued by structures set up by [[government-sponsored enterprise]]s like [[Fannie Mae]] or [[Freddie Mac]], or they can be "private-label", issued by structures set up by investment banks. The structure of the MBS may be known as "pass-through", where the interest and principal payments from the borrower or homebuyer pass through it to the MBS holder, or it may be more complex, made up of a pool of other MBSs. Other types of MBS include [[collateralized mortgage obligation]]s (CMOs, often structured as real estate mortgage investment conduits) and [[collateralized debt obligation]]s (CDOs).<ref>Lemke, Lins and Picard, ''Mortgage-Backed Securities'', Chapters 4 and 5 (Thomson West, 2013 ed.).</ref>

The shares of subprime MBSs issued by various structures, such as CMOs, are not identical but rather issued as [[tranche]]s (French for "slices"), each with a different level of priority in the debt repayment stream, giving them different levels of risk and reward. Tranches{{snd}}especially the lower-priority, higher-interest tranches{{snd}}of an MBS are/were often further repackaged and resold as collaterized debt obligations.<ref>Josh Clark, [http://www.howstuffworks.com/mortgage-backed-security.htm "How can mortgage-backed securities bring down the U.S. economy?"], How Stuff Works</ref> These subprime MBSs issued by investment banks were a major issue in the [[subprime mortgage crisis]] of 2006–2008
.
The total face value of an MBS decreases over time, because like mortgages, and unlike [[Bond (finance)|bonds]], and most other fixed-income securities, the [[Debt|principal]] in an MBS is not paid back as a single payment to the bond holder at maturity but rather is paid along with the interest in each periodic payment (monthly, quarterly, etc.). This decrease in face value is measured by the MBS's "factor", the percentage of the original "face" that remains to be repaid.

===Options===
In [[finance]], an '''[[Option (finance)|option]]''' is a contract which gives the ''buyer'' (the owner) the right, but not the obligation, to buy or sell an underlying asset or [[financial instrument|instrument]] at a specified [[strike price]] on or before a specified [[expiration (options)|date]]. The ''seller'' has the corresponding obligation to fulfill the transaction{{snd}}that is to sell or buy{{snd}}if the buyer (owner) "exercises" the option. The buyer pays a premium to the seller for this right. An option that conveys to the owner the right to buy something at a certain price is a "[[call option]]"; an option that conveys the right of the owner to sell something at a certain price is a "[[put option]]". Both are commonly traded, but for clarity, the call option is more frequently discussed.
Options valuation is a topic of ongoing research in academic and practical finance. In basic terms, the value of an option is commonly decomposed into two parts:
* The first part is the "intrinsic value", defined as the difference between the market value of the underlying and the strike price of the given option.
* The second part is the "time value", which depends on a set of other factors which, through a multivariable, non-linear interrelationship, reflect the [[discounted]] [[expected value]] of that difference at expiration.

Although options valuation has been studied since the 19th century, the contemporary approach is based on the [[Black–Scholes model]], which was first published in 1973.<ref>{{cite journal |first=Eric |last=Benhamou |title=Options pre-Black Scholes |url=http://www.ericbenhamou.net/documents/Encyclo/Pre%20Black-Scholes.pdf |access-date=December 26, 2014 |archive-date=October 10, 2015 |archive-url=https://web.archive.org/web/20151010195626/http://www.ericbenhamou.net/documents/Encyclo/Pre%20Black-Scholes.pdf |url-status=usurped }}</ref>{{Unreliable source?|date=August 2013}}<ref>{{cite journal |last1 =Black |first1= Fischer |first2= Myron |last2=Scholes |year=1973 |title=The Pricing of Options and Corporate Liabilities |journal =[[Journal of Political Economy]] |volume=81 |issue=3 |pages=637–654 |jstor=1831029 |doi=10.1086/260062|s2cid= 154552078 }}</ref>

Options contracts have been known for many centuries. However, both trading activity and academic interest increased when, as from 1973, options were issued with standardized terms and traded through a guaranteed clearing house at the [[Chicago Board Options Exchange]]. Today, many options are created in a standardized form and traded through clearing houses on regulated [[Exchange (organized market)|options exchanges]], while other [[Over-the-counter (finance)|over-the-counter]] options are written as bilateral, customized contracts between a single buyer and seller, one or both of which may be a dealer or market-maker. Options are part of a larger class of financial instruments known as [[derivative products]] or simply derivatives.<ref name="hull"/><ref>{{Citation
|last1=Brealey
|first1=Richard A.
|author-link=Richard A. Brealey
|last2=Myers
|first2=Stewart
|author2-link=Stewart Myers
|title=Principles of Corporate Finance
|publisher=McGraw-Hill
|year=2003
|edition=7th
|id=Chapter 20
|title-link=Principles of Corporate Finance
}}</ref>

===Swaps===
A '''swap''' is a derivative in which two [[counterparty|counterparties]] [[trade|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 [[Bond (finance)|bonds]], the benefits in question can be the periodic interest ([[Coupon (bond)|coupon]]) payments associated with such bonds. Specifically, two counterparties agree to the exchange one stream of [[cash flow]]s against another stream. These streams are called the swap's "legs". The swap agreement defines the dates when the cash flows are to be paid and the way they are [[Accrual|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.<ref name="hull"/>

The cash flows are calculated over a [[notional principal amount]]. Contrary to a [[futures contract|future]], a [[forward contract|forward]] or an [[option (finance)|option]], the notional amount is usually not exchanged between counterparties. Consequently, swaps can be in cash or [[collateral (finance)|collateral]].
Swaps can be used to [[hedge (finance)|hedge]] certain risks such as [[interest rate risk]], or to [[speculation|speculate]] on changes in the expected direction of underlying prices.

Swaps were first introduced to the public in 1981 when [[IBM]] and the [[World Bank]] entered into a swap agreement.<ref>{{cite book |title=Fundamentals of Corporate Finance |edition=9th | last1=Ross |last2=Westerfield |last3=Jordan |year=2010 |publisher=[[McGraw Hill]] |page=746 }}</ref> Today, swaps are among the most heavily traded financial contracts in the world: the total amount of interest rates and currency swaps outstanding is more than $348 trillion in 2010, according to the [[Bank for International Settlements]] (BIS).{{citation needed|date=December 2014}} The five generic types of swaps, in order of their quantitative importance, are: [[interest rate swap]]s, [[currency swap]]s, credit swaps, [[commodity swap]]s and [[equity swap]]s (there are many other types).