There are four basic types of derivatives – Forward Contracts, Futures Contracts, Options Contracts, and Swaps. Moreover, they are often regarded as a tool of speculation, which can result in substantial losses. Further, derivatives face the possibility of counterparty default. The same tends to be highly volatile, which exposes them to the probability of significant losses. However, there are risks associated with derivatives. An example of an interest rate swap is where parties simply swap fixed interest payments for floating-rate paymentsĭerivatives – Advantages, Risks, and Four Basic Typesĭerivatives are used typically to hedge risks, frequently determined by the price of the underlying asset, provide access to markets or assets that would otherwise be unavailable, and enhance the efficiency of financial markets.One type of fixed income derivatives is called swaps – examples are interest rate, cross-currency, and equity swaps. There are four basic types of derivatives – forward contracts, futures contracts, options contracts, and swaps.There are some advantages and disadvantages of derivatives.Derivatives can be used to mitigate risk (such as in hedging) or to ‘take on’ risk (such as speculative investing).
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