Global Securities Markets: Navigating the World's Exchanges and OTC Markets

LEGAL DEFINITION OF DERIVATIVES

Derivatives are financial instruments whose value is derived from the value of an underlying asset (e.g., the price of an equity, bond, or commodity) or market variable (e.g., an interest rate, an exchange rate, or a stock index). The main types of derivatives are futures, options, and swaps. Options, particularly listed options, are well known in the United States and Europe and will not be covered in any depth in this book. A central counterparty, the Options Clearing Corporation, and various exchanges, notably the Chicago Board Option Exchange, support the trading of U.S.-listed options. LIFFE and Eurex perform similar functions in the United Kingdom and Europe. Another type of derivative, the credit derivative, takes its value from underlying assets like loans, bonds, and other forms of credit. The main type of credit derivative is the Credit Default Swap (CDS). Given its prominence in the most recent financial collapse, we examine briefly CDS. Then we look at another popular derivative, the contract for difference (CFD), because—like listed options—CFDs are popular with retail investors.2