The widespread use of derivatives makes the market more complete and competitive on the one hand, and creates vast and complicated new financial management tasks and techniques on the other.” Three major types of derivatives securities widely used in risk management are swap, forwards/futures and options.
Table 11.6: Difference between Forwards and Futures:
OTC/Private contracts between two parties. Customised
Usually one specified delivery date Settled at maturity
Delivery or final cash settlement usually takes place
Exchange traded involving a clearing house. Standardised A range of delivery dates Daily resettlement
Contracts usually closed out prior to maturity
The global financial market offers a wide range of instruments, mostly derivatives to manage or mitigate unwanted risks. “Interest rate risk can be hedged through interest rate swaps or by operating in futures market.
Forward exchange rate transactions or foreign exchange options can be used to deal with exchange rate risk. Credit risk can be transferred to other market participants or investors via securitisation including the use of structured financial products such as asset-backed securities (ABS), collateralised debt obligation (CDO) or through the purchase of credit default swaps (CDS).”