ABSTRACT
Derivative is a generic term that includes contracts, options, and swaps. Forward contracts are varied, but they all tend to deal with the same aspects of a forward sale. However, there is a large business conducted outside of these exchanges in the over-the-counter market to supplement futures contracts and better meet the needs of individual companies. Swaps differ from exchange-traded futures and options in that, because swaps are individually negotiated instruments, users can customize them to suit the risk management activities to a greater degree than is easily accomplished with more standardized futures contracts or exchange-traded options. Although swaps can be highly customized, the parties are exposed to high loss risk because the contracts generally are not guaranteed by a clearinghouse as are exchange-traded derivatives. The advent of financial instruments such as futures contracts, options, and swaps allows customers to procure the commodity and manage price risks as separate unbundled activities.
