Interest Rate Derivatives

Interest Rate Derivatives

Derivative(1) A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of ..... is a product whose value is derived from the value of one or more basic variables. The basic variables are underlyingThe designated financial instrument which must be delivered in completion of an option or futures contract. assets, index or may be a reference rate and are known as Bases. The asset can be an equityThe ownership interest in a company of holders of its common and preferred stock. , a currency, a commodity etc.

The classification of the derivatives is done on the basisIn a futures market, basis is defined as the cash price (or spot price) of whatever is being traded minus its futures price for the ..... of the underlying asset such as

1. Equity Derivatives
2. Forex Derivatives
3. Commodity Derivatives
4. Interest Rate Derivatives.

The Derivatives includes the following:

• A security that is derived from a debt instrument , share, loan whether secured or unsecured
• A contract that derives its value from the prices.

The derivatives cane be OTC Derivatives or Over The Counter Derivatives or ExchangeRegulated market place where capital market products are bought and sold through intermediaries. Traded Market derivatives. They are discussed as follows:

• OTC Derivatives:
  

  In simple words OTC or Over the Counter derivatives are private , bilateral contracts in which the two parties agree on how the trade has to be settled in Future. It is done over the Telephone and is of two kinds viz. Forward and Swaps
  

  • Forwards: This is the simplest derivative instrument. In this a private agreement is held between the two parties and one party (buyer) agrees to buy from other party (seller) an asset at a future date. Here there are two prices play role
    • Spot Price: Price when the contract is made.
    • Forward Price: Price when the contract matures.

    This future date is fixed at the start of the contract. When the date arrives there are two options to settle this contract:

    • The forward contractAn agreement for the future delivery of the underlying commodity or security at a specified price at the end of a designated period of time. ..... is settled by the physical deliveryPresentation of securities with transfer deeds in fulfillment of a transaction. of the underlying asset by the seller to the buyer.
    • Both parties may go for a cash settlementThe settlement provision on some options and futures contracts that do not require delivery of the underlying security. For options, the difference between the settlement ...... In the cash settlement if the difference between the spot and forward is paid to the party which is eligible for it.
  • Interest Rate SwapA financial transaction which exploits arbitrage opportunities between markets and in which two counter parties agree to exchange streams of payments over time according to .....:
    

    Interest Rate SwapContract in which two parties agree to swap interest payments for a predetermined period of time – traded in the OTC market. is an over-the-counter (OTC) derivative instrument available in the currency market where counter parties can exchange a floating payment for a fixed payment and vice-versa related to an interest rate. Most common parties that go for Interest Rate SwapsInterest Rate Swap is basically a contractual arrangement between two parties which are called "Counterparties". Commonly the counterparties are a Financial Institution and an issuer. ..... are the financial institutions going for foreign borrowings with an objective to hedgeAn asset, liability or financial commitment that protects against adverse changes in the value of or cash flows from another investment or liability. An unhedged ..... their interest rate exposure due to fluctuating interest ratesWhen a person borrows some money from another person, this money comes at an interest which can also be called the "Opportunity Cost" of the .....