SAXO BANK
Hedge Fund Consistency Index, Hedge Funds Research
Hedge Fund Consistency Index  
Midwest Office:
641-472-7373 Ext.112
News Books Scholarly Definitions


FREE ACCESS!
Subscribe for
Free Access
to over 4000+ pages of Profiles and Top 20 Rankings. No obligation ever.


User Name:

Password:




 
Derivatives                            

CONTRIBUTE articles, books, comments, links, news,
and/or scholarly or white papers - by clicking 

 

  1. Definition
  2. Examples, Types, or Variations
  3. Formula
  4. Related Terms
  5. As Used in the Hedge Fund World
  6. Applications
  7. Misused & Abused
  8. Additional Sources of Information
    1. Books
    2. News
    3. Scholarly Papers
       
 

1.
 

Definition
 
  Derivatives are financial instruments whose value is derived from the value of something else. They generally take the form of contracts under which the parties agree to payments between them based upon the value of an underlying asset or other data at a particular point in time. The main types of derivatives are futures, forwards, options and swaps.

The main use of derivatives is to minimize risk for one party while offering the potential for a high return (at increased risk) to another. The diverse range of potential underlying assets and payoff alternatives leads to a huge range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) — see inflation derivatives — or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the payoffs.

Other Resources:

  • Risk Glossary: A derivative instrument (or simply derivative) is a financial instrument which derives its value from the value of some other financial instrument or variable. More…
     
  • PTI Securities & Futures L.P.: A financial instrument, traded on or off an exchange, the price of which is directly dependent upon the value of one or more underlying securities, equity indices, debt instruments, commodities, other derivative instruments, or any agreed upon pricing index or arrangement. More…
     
  • The London Bullion Market Association: A financial instrument derived from a cash market commodity, futures contract or other financial instrument. More…
     
  • Tepper Investment Club: A financial instrument whose value is based on the performance of an underlying financial asset, index, or other investment. More…
     

Contribute to this section by clicking                    top

 

2.
 

Examples, Types, or Variations
 
  The derivatives markets are the financial markets for derivatives. The market can be divided into two, that for exchange traded derivatives and that for over-the-counter derivatives. The legal nature of these products is very different as well as the way they are traded, though many market participants are active in both.

Examples of Common Derivatives:
 

UNDERLYING

INSTRUMENT TYPE

Exchange traded futures

Exchange traded options

OTC swap

OTC forward

OTC option

Money market

Eurodollar future
Euribor future

Option on Eurodollar future
Option on Euribor future

Interest rate swap

Forward rate agreement

Interest rate cap and floor
Swaption
Basis swap

Bonds

Bond future

Option on Bond future

n/a

Repurchase agreement

Bond option

Stocks

Single-share future

Single-share option

Equity swap

Repurchase agreement

Stock option
Warrant
Turbo warrant

Foreign exchange

FX future

Option on FX future

Currency swap

FX forward

FX option

Credit

n/a

n/a

Credit default swap

n/a

Credit default option

Over-the-counter (OTC) derivatives are contracts that are traded between two parties directly, without going through an exchange. Products such as swaps, forward rate agreements, and exotic options are always traded in this way. The OTC derivatives market is huge. According to BIS, the total outstanding notional amount is USD 248 trillion at the end of December 2004.

Exchange-traded derivatives are those derivatives products that are traded via specialized Derivatives exchanges or other exchanges. A derivatives exchange acts as an intermediary to all related transactions, and takes Initial margin from both sides of the trade to act as a guarantee. The world's largest[2] derivatives exchanges (by number of transactions) are the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of the 2007 merger of the Chicago Mercantile Exchange and the Chicago Board of Trade). According to BIS, the combined turnover in the world's derivatives exchanges totalled USD 344 trillion during Q4 2005. Some types of derivative instruments also may trade on traditional exchanges. For instance, hybrid instruments such as convertible bonds and/or convertible preferred may be listed on stock or bond exchanges. Also, warrants (or "rights") may be listed on equity exchanges. Performance Rights, Cash xPRTs(tm) and various other instruments that essentially consist of a complex set of options bundled into a simple package are routinely listed on equity exchanges. Like other derivatives, these publicly traded derivatives provide investors access to risk/reward and volatility characteristics that, while related to an underlying commodity, nonetheless are distinctive.

 

Other Resources:

  • WR Hambrecht + Co: Three classes of financial products fall under the heading of derivatives: derivative securities; exchange-traded derivatives; and over-the-counter (OTC) derivatives. More…
     

Contribute to this section by clicking                    top

 

3.
 

Formula
 
   

Contribute to this section by clicking                    top

 

4.
 

Related Terms
 
 
  • Money Market
  • Bonds
  • Stocks
  • Foreign Exchange
  • Credit
  • Derivatives Market
  • Equity Swap
  • Credit Derivative
  • Forward Contract
  • Futures
  • Hybrid Security
  • Option
  • Rho
     

Contribute to this section by clicking                    top

 

5.
 

As Used in the Hedge Fund World
 
  Other Resources:
  • Wikipedia:

    Insurance
    One use of derivatives is as a tool to transfer risk. For example, farmers can sell futures contracts on a crop to a speculator before the harvest. The farmer offloads (or hedges) the risk that the price will rise or fall, and the speculator accepts the risk with the possibility of a large reward. The farmer knows for certain the revenue he will get for the crop that he will grow; the speculator will make a profit if the price rises, but also risks making a loss if the price falls.

    It is not unknown for farmers to walk away smiling, when they have lost out in the derivatives market, as the result of a hedge. In this case, they have profited from the real market from the sale of their crops. Contrary to popular belief, financial markets are not always a zero-sum game. This is an example of a situation where both parties in a financial markets transaction benefit.

    Speculation
    Of course, speculators may trade with other speculators as well as with hedgers. In most financial derivatives markets, the value of speculative trading is far higher than the value of true hedge trading. As well as outright speculation, derivatives traders may also look for arbitrage opportunities between different derivatives on identical or closely related underlying securities.

    Other uses of derivatives are to gain an economic exposure to an underlying security in situations where direct ownership of the underlying is too costly or is prohibited by legal or regulatory restrictions, or to create a synthetic short position.

    In addition to directional plays (i.e. simply betting on the direction of the underlying security), speculators can use derivatives to place bets on the volatility of the underlying security. This technique is commonly used when speculating with traded options.

    Speculative trading in derivatives gained a great deal of notoriety in 1995 when Nick Leeson, a trader at Barings Bank, made poor and unauthorized investments in index futures. Through a combination of poor judgment on his part, lack of oversight by management, a naive regulatory environment and unfortunate outside events, Leeson incurred a 1.3 billion dollar loss that bankrupted the centuries old financial institution. 

Contribute to this section by clicking                    top

 

6.
 

Applications
 
   

Contribute to this section by clicking                    top

 

7.
 

Misused & Abused
 
  An individual or a corporation should carefully weigh the risks of using derivatives since losses can be greater than the money put into these instruments. It should be understood that derivatives themselves are not to be considered investments since they are not an asset class. They simply derive their values from assets such as bonds, equities, currencies etc. and are used to either hedge those assets or improve the returns on those assets.

Other Resources:

Contribute to this section by clicking                    top

 

8.
 

Additional Sources of Information
 
 
  1. Books
  2. News
  3. Scholarly Papers

 

Back to Terms

News Books Scholarly Definitions

HEDGE FUND RISK AND OTHER DISCLOSURES
Hedge funds, including fund of funds (“Hedge Funds”), are unregistered private investment partnerships, funds or pools that may invest and trade in many different markets, strategies and instruments (including securities, non-securities and derivatives) and are NOT subject to the same regulatory requirements as mutual funds, including mutual fund requirements to provide certain periodic and standardized pricing and valuation information to investors. There are substantial risks in investing in Hedge Funds. Persons interested in investing in Hedge Funds should carefully note the following:
  • Hedge Funds represent speculative investments and involve a high degree of risk. An investor could lose all or a substantial portion of his/her investment. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment in a Hedge Fund.
  • An investment in a Hedge Fund should be discretionary capital set aside strictly for speculative purposes.
  • An investment in a Hedge Fund is not suitable or desirable for all investors. Only qualified eligible investors may invest in Hedge Funds.
  • Hedge Fund offering documents are not reviewed or approved by federal or state regulators
  • Hedge Funds may be leveraged (including highly leveraged) and a Hedge Fund’s performance may be volatile
  • An investment in a Hedge Fund may be illiquid and there may be significant restrictions on transferring interests in a Hedge Fund. There is no secondary market for an investor’s investment in a Hedge Fund and none is expected to develop.
  • A Hedge Fund may have little or no operating history or performance and may use hypothetical or pro forma performance which may not reflect actual trading done by the manager or advisor and should be reviewed carefully. Investors should not place undue reliance on hypothetical or pro forma performance.
  • A Hedge Fund’s manager or advisor has total trading authority over the Hedge Fund.
  • A Hedge Fund may use a single advisor or employ a single strategy, which could mean a lack of diversification and higher risk.
  • A Hedge Fund (for example, a fund of funds) and its managers or advisors may rely on the trading expertise and experience of third-party managers or advisors, the identity of which may not be disclosed to investors
  • A Hedge Fund may involve a complex tax structure, which should be reviewed carefully.
  • A Hedge Fund may involve structures or strategies that may cause delays in important tax information being sent to investors.
  • A Hedge Fund may provide no transparency regarding its underlying investments (including sub-funds in a fund of funds structure) to investors. If this is the case, there will be no way for an investor to monitor the specific investments made by the Hedge Fund or, in a fund of funds structure, to know whether the sub-fund investments are consistent with the Hedge Fund’s investment strategy or risk levels.
  • A Hedge Fund may execute a substantial portion of trades on foreign exchanges or over-the-counter markets, which could mean higher risk.
  • A Hedge Fund’s fees and expenses-which may be substantial regardless of any positive return- will offset the Hedge Fund’s trading profits. In a fund of funds or similar structure, fees are generally charged at the fund as well as the sub-fund levels; therefore fees charged investors will be higher that those charged if the investor invested directly in the sub-fund(s).
  • Hedge Funds are not required to provide periodic pricing or valuation information to investors.
  • Hedge Funds and their managers/advisors may be subject to various conflicts of interest.
The above general summary is not a complete list of the risks and other important disclosures involved in investing in Hedge Funds and, with respect to any particular Hedge Fund, is subject to the more complete and specific disclosures contained in such Hedge Fund’s respective offering documents. Before making any investment, an investor should thoroughly review a Hedge Fund’s offering documents with the investor’s financial, legal and tax advisor to determine whether an investment in the Hedge Fund is suitable for the investor in light of the investor’s investment objectives, financial circumstances and tax situation.

All performance information is believed to be net of applicable fees unless otherwise specifically noted. No representation is made that any fund will or is likely to achieve its objectives or that any investor will or is likely to achieve results comparable to those shown or will make any profit at all or will be able to avoid incurring substantial losses. Past performance is not necessarily indicative, and is no guarantee, of future results.

The information on the Site is intended for informational, educational and research purposes only. Nothing on this Site is intended to be, nor should it be construed or used as, financial, legal, tax or investment advice, be an opinion of the appropriateness or suitability of an investment, or intended to be an offer, or the solicitation of any offer, to buy or sell any security or an endorsement or inducement to invest with any fund or fund manager. No such offer or solicitation may be made prior to the delivery of appropriate offering documents to qualified investors. Before making any investment, you should thoroughly review the particular fund’s confidential offering documents with your financial, legal and tax advisor and conduct such due diligence as you (and they) deem appropriate. We do not provide investment advice and no information or material on the Site is to be relied upon for the purpose of making investment or other decisions. Accordingly, we assume no responsibility or liability for a ny investment decisions or advice, treatment, or services rendered by any investor or any person or entity mentioned, featured on or linked to the Site.

The information on this Site is as of the date(s) indicated, is not a complete description of any fund, and is subject to the more complete disclosures and terms and conditions contained in a particular fund's offering documents, which may be obtained directly from the fund. Certain of the information, including investment returns, valuations, fund targets and strategies, has been supplied by the funds or their agents, and other third parties, and although believed to be reliable, has not been independently verified and its completeness and accuracy cannot be guaranteed. No warranty, express or implied, representation or guarantee is made as to the accuracy, validity, timeliness, completeness or suitability of this information.

Any indices and other financial benchmarks shown are provided for illustrative purposes only, are unmanaged, reflect reinvestment of income and dividends and do not reflect the impact of advisory fees. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular hedge fund. For example, a hedge fund may typically hold substantially fewer securities than are contained in an index. Indices also may contain securities or types of securities that are not comparable to those traded by a hedge fund. Therefore, a hedge fund’s performance may differ substantially from the performance of an index. Because of these differences, indexes should not be relied upon as an accurate measure of comparison.




 |  Privacy Notice  |  Industry Links  |  Terms Of Use  | 

Hedge Fund Data Licensed to Mt. Rushmore Securities LLC by Barclay Trading Group, Ltd.
© Mt. Rushmore Securities LLC, Member NASD, SIPC