Derivatives contract

derivatives

A derivatives contract is a document, which reflects a contractual agreement on the evolution of an asset, called the underlying asset.

The most widely used contract model in financial hedging and leverage operations is the ISDA (International Swaps and Derivatives Association).

These contracts have to define exactly both the general and the specific terms that influence the operations. Significant changes in the price due to a split, capital increases, trading suspensions, interest rates charged and their spreads, the methods applied to avoid defaults between the parties, the clearing houses, forms and time of settlement, deposit should appear. , financial entities that allow the exchange.

There is a wide variety of derivative contracts on currencies, metals, commodities, indices, stocks, bonds, interest rates.

On the other hand, there are models of financial contracts in non-organized OTC (Over the counter) markets, where there is no clearing house, being bilateral agreements that are negotiated with counterparties, generally market makers where, unlike organized markets, the investor will not have to deposit guarantees, there are netting and collateral agreements with the other party involved in the negotiation. This type of contract has a higher risk, since its assets are difficult to value and control.

This market has grown exponentially in recent years, and has been one of those responsible for the expanding economic crisis. For this reason, regulators are trying to limit and control the operations made to measure for each operation or client, thanks to the new Dodd-Frank law, which establishes that all OTC financial contracts are subject to supervision by financial regulators but, nevertheless, not includes the control of the net positions of the broker in the market or the percentage of coverage of the positions of its clients, and there may be conflicts of interest between the parties, in many cases, contrary to investors and with price differentials well above of the market.

On the other hand, it is important to note that in the US 90% of OTC derivatives are in the hands of four banks.

Types of financial derivatives

There are different types of financial derivatives:

  • Futures: They are traded in organized markets. They are standardized contracts.
  • Forward: They are traded in OTC markets. They are term contracts settled for differences.
  • Options: A premium is paid that represents a proportion of the value of the option, the investor has the right to buy or sell an asset at an agreed price. Options are generally traded on organized markets, although it is becoming more and more common to see OTC options.
  • Swaps: They are listed in OTC markets, have a future maturity and are settled by the difference between the future prices of the underlying asset and the price that was agreed.

To be able to trade derivative products, the provision of guarantees is necessary. In the case of organized markets, the investor will have to cover the market guarantees, however, in unorganized markets, the investor will have to cover the guarantee established by the counterparty.

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