Classification of Derivatives – Forward, Futures, Options, Swaps

The Derivatives family has 4 main members.

1. Classification by Market

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2. The Big 4 Instruments

1. Forwards: Agreement to buy/sell at future date. (Customized).
2. Futures: Same as Forward, but Standardized and Traded on Exchange.
3. Options: Gives the Right (but not obligation) to buy/sell. (Like Insurance).
4. Swaps: Agreement to Exchange cash flows (e.g., Fixed Interest vs Floating Interest).

3. Diagram: The Family Tree

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4. Exam Notes: Writing the Answer

Question: "Classify Financial Derivatives." (10 Marks)

Answering Strategy:

1. Tree Diagram: Draw the Market-based classification (OTC vs Exchange).
2. Define Each: Write 2 lines for each of the 4 types (Forward, Future, Option, Swap).
3. Key Distinction: Emphasize "Obligation" (Forward/Future/Swap) vs "Right" (Option).

Summary

• Evolution: It started with Forwards (simple), moved to Futures (safe), then Options (flexible), and Swaps (complex).

Quiz Time! 🎯

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