An Introduction to Bond Markets, Fourth Edition

Chapter 11

INTRODUCTION TO DERIVATIVE INSTRUMENTS

One of the success stories of the global capital markets is the growth in the use of derivatives, or off-balance sheet instruments. The products now traded by virtually all participants in financial markets include forward contracts, futures, swaps and options. These instruments are used as tools in their own right, as well as to form the building blocks of more complex structures or structured products. Derivative instruments are often tailored by a bank to meet the specific requirements of a particular customer, so-called over-the-counter (OTC) products. The range of uses to which derivatives are put is as varied as the types of instrument available; as we might expect, the subject area is a large one, and a great deal has been written about the use of derivatives. Because these instruments are widely used and an integral part of the operations of the debt capital markets, it is worthwhile to consider them here. The subject matter is large; so, even though this is an introduction, the chapter is a large one.

 

We will look at the various types of off-balance sheet (OBS) instruments that are traded as part of the operations of a bond desk within a bank. This will include descriptions of the instruments, as well as a brief look at pricing, trading and some uses. We can of course only touch upon the issue, which is a huge subject in its own right. There are a large number of uses for derivatives, due to their flexibility and versatility ...