Forward,futures and Swaps

INVESTMENTS

Forwards, Futures & Swaps

Interest Rate Derivatives

Interest rate swaps, caps, floors, and swaptions are over the counter (OTC) interest rate derivatives.

Broadly defined, a derivative instrument is a formal agreement between two parties specifying the exchange of cash payments based on changes in the price of a specified underlying item or differences in the returns of different securities.

For example, interest rate swaps are based on differences be-tween two different interest rates, while interest rate caps/floors are option like instruments

on interest rates.

Unlike the organized exchanges, the OTC market is an informal market

consisting of dealers or market makers, who trade price information and negotiate transactions over electronic communications networks.

Although a great deal of contract standardization exists in the OTC market, dealers active in this market custom tailor agreements to meet the specific needs of their customers.

And unlike the organized exchanges, where the exchange clearinghouses guarantee contract performance through a system of margin requirements

combined with the daily settlement of gains or losses, counterparties

to OTC derivative agreements must bear some default or credit risk.

According to data released by BIS, the total estimated notional amount of outstanding OTC contracts stood at $94 trillion at end June 2000. The interest segment expanded by 7%, to $64.1 trillion.

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