Derivative Instruments: Products and Applications: Introduction and Overview

This chapter presents an overview of derivative instruments, their trading and applications. The four main derivative products—forwards, futures, options, and swaps—are described and their uses are explained. Derivative instruments in their current form are relatively new instruments. Compared to financial assets such as stocks and bonds, which have been exchange traded for more than a century, derivative instruments, especially financial derivatives, are very new instruments. This chapter examines the rationale for the evolution of derivatives and how the latter instruments were an improvement to existing ones. The key players in derivatives markets are discussed and the differences between commodity and financial derivatives are examined. The chapter also examines in detail the mechanics of how forwards, futures, options, and swaps function. The comparative advantage of each instrument and how it can be used in hedging or risk management is explored.