Comparison – Forward vs Futures vs Options vs Swaps
1. Introduction
We have covered the "Big 4" instruments. To ace the exam, you must be able to compare them in a single view.
2. The Grand Comparison Table
| Feature | Forward | Future | Option | Swap |
|---|---|---|---|---|
| Trading Venue | OTC (Private) | Exchange (Public) | Exchange / OTC | OTC (Private) |
| Obligation | Yes (Both parties) | Yes (Both parties) | No (Right Only) | Yes (Both parties) |
| Customization | High (Tailor made) | None (Standardized) | Standardized | High |
| Default Risk | High | Zero (Clearing House) | Zero (Exchange Traded) | High |
| Upfront Cost | None | Initial Margin | Premium | None |
| Settlement | At Expiry | Daily MTM | At Expiry | Periodic (Multiple) |
| Duration | Short Term | Short Term | Short/Medium | Long Term (Years) |
| Typical User | Exporters / Banks | Speculators / Traders | Hedgers / Insurers | Corporations / Banks |
3. Summary of Use Cases
- Forward: "I need to buy exactly $125,500 on 14th Feb." (Custom Need).
- Future: "I think market is bullish and I want to trade with safety." (Trading).
- Option: "I want to protect against loss but keep profit potential open." (Insurance).
- Swap: "I have a 10-year loan and want to change interest from Floating to Fixed." (Structuring).
4. Exam Notes: Writing the Answer
Question: "Compare and contrast the different types of Financial Derivatives." (15 Marks)
Answering Structure:
- Format: Draw the table above. It is the best way to score marks.
- Key Distinction: Highlight that Options are unique because of the "Right mechanism", and Futures are unique because of "Daily Settlement".
- Swaps: Mention they are for "Long Term".
5. Final Quiz! 🎯
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