Derivatives, Every Angle

A bilateral OTC agreement to buy or sell an underlying at a fixed price on a specified future date — the simplest derivative structure. No cash changes hands until settlement; unlike an option there's no premium, and unlike a future there's no daily margining.

Real-world exampleFX forwards (Part V) are the highest-volume forward type, used extensively by corporates to hedge known future foreign-currency cash flows.

The exchange-traded, standardized version of a forward — same basic idea, but with standardized sizes and expiries, and a central counterparty (CCP) that becomes the buyer to every seller and seller to every buyer, eliminating bilateral counterparty risk.

Real-world exampleNick Leeson's unauthorized, concentrated trading in Nikkei 225 futures and options at Barings Bank's Singapore office produced losses of roughly $1.3 billion, collapsing the 233-year-old bank in 1995 — still one of the most-cited lessons on position limits and separating trading from settlement duties.

An OTC contract to lock in an interest rate for a specific future period on a notional amount — the simplest possible interest rate derivative, and conceptually the building block for an interest rate swap (which is essentially a strip of FRAs).

Real-world exampleCorporate treasurers use FRAs extensively to hedge a known future borrowing or lending rate — for instance, locking in the rate on a loan drawdown expected in three months.

An agreement to exchange a stream of fixed-rate interest payments for a stream of floating-rate payments (or vice versa) on a common notional over an agreed term — by outstanding notional, the single largest derivatives market in the world.

Real-world exampleA corporate borrower with a floating-rate loan commonly enters a pay-fixed/receive-floating IRS to convert its exposure to a predictable fixed rate — one of the most common corporate hedging applications of any derivative.

A swap exchanging a fixed rate for a floating rate based on the compounded overnight rate (SOFR, €STR, SONIA) over the term — distinct from a standard IRS, which typically references a term rate. OIS has become the dominant reference for discounting derivative cash flows industry-wide.

Real-world exampleThe industry-wide shift to OIS discounting for collateralized derivatives after 2008 was a major valuation methodology change, since posting cash collateral overnight effectively funds a position at the overnight rate, not a term rate.

A swap exchanging two different floating-rate exposures against each other — for instance, 3-month SOFR versus 6-month SOFR — rather than fixed-for-floating like a standard IRS.

Real-world exampleA bank funding itself with 3-month liabilities but lending on a 6-month-reset basis has a natural mismatch a basis swap can hedge precisely, without taking outright interest-rate direction risk.

A swap exchanging interest payments — and, unlike most swaps, principal — in two different currencies over the trade's life, used to convert a liability or asset from one currency into another on a fully hedged basis.

Real-world exampleA European corporate issuing a USD bond to access deeper US capital markets will typically enter a cross-currency swap to convert proceeds and coupon obligations back into EUR, eliminating FX risk on the whole financing.

A package combining a fixed-rate bond with an interest rate swap that converts the bond's fixed coupon into a floating-rate cash flow — letting an investor hold a specific bond's credit exposure while receiving a floating return.

Real-world exampleThe asset swap spread is one of the most common ways credit traders quote and compare bond value across different coupons and maturities, isolating credit risk from distortions a simple yield comparison can introduce.

A swap where one party pays the total return (price appreciation plus dividends) of a stock, basket, or index, and receives a floating funding rate in return — giving the receiver synthetic, leveraged exposure without ever owning the underlying directly.

Real-world exampleArchegos Capital Management used total return swaps with several prime brokers to build roughly $20 billion of concentrated, leveraged, largely undisclosed exposure to a handful of stocks. When positions fell in March 2021, forced liquidation produced roughly $10 billion of combined bank losses — Credit Suisse alone lost about $5.5 billion — one of the starkest illustrations of how synthetic exposure can hide real economic risk from regulators and even other counterparties.

An OTC contract paying the difference between an asset's price at opening and closing, letting a trader take leveraged directional views on virtually any asset — equities, indices, commodities, FX — without ever owning the underlying.

Real-world exampleCFDs are a dominant retail trading product in the UK, Australia, and much of Europe, precisely because they're prohibited for US retail investors — a clear illustration of how derivatives regulation varies sharply by jurisdiction.

A future or forward on a physical commodity — oil, natural gas, gold, wheat, and hundreds of other underlyings — used by producers and consumers to lock in prices, and by speculators to take a view on price direction.

Real-world exampleMetallgesellschaft's US oil subsidiary lost roughly $1.3 billion in the early 1990s from a large short-dated futures hedging programme against long-term supply contracts, when the curve moved from backwardation into contango and generated large, unexpected margin calls the parent could not sustain — a classic lesson in roll risk and liquidity mismatch between a hedge's cash-flow timing and the exposure it's meant to protect.

A swap exchanging a fixed commodity price for a floating (market-referenced) price over multiple periods — letting a producer or consumer lock in an effective price across a longer horizon than a single futures contract typically covers.

Real-world exampleAn airline hedging jet fuel costs, or a mining company hedging copper output, will commonly use a series of commodity swaps to lock in effective prices across future quarters as part of a broader hedging programme.

A contract where the protection buyer pays a periodic premium (the "CDS spread") to the protection seller, who agrees to compensate the buyer if a specified credit event (default, bankruptcy, or a defined restructuring) occurs on a specific reference entity's debt — functionally, insurance against a specific issuer defaulting.

Real-world exampleCDS spreads are among the most closely watched real-time indicators of a company's or sovereign's perceived credit risk, often reacting faster to negative news than the underlying bond's own price.

A standardized CDS contract referencing a basket of typically 100–125 investment-grade or high-yield corporate names rather than a single issuer — CDX covers North American and EM names, iTraxx covers European and Asian names, with a new "series" issued roughly every six months.

Real-world exampleJPMorgan's Chief Investment Office, run by trader Bruno Iksil ("the London Whale"), built an outsized position in the CDX.NA.IG.9 index in 2012 that grew so large it distorted the index's own pricing relative to its constituents; unwinding it produced losses that grew from an initially disclosed $2 billion to roughly $6.2 billion in total.

The fixed income counterpart to the equity TRS in Part II — one party pays the total return (price change plus coupon income) of a bond or loan, and receives a floating funding rate, giving the receiver synthetic exposure without directly owning or funding the underlying.

Real-world exampleTotal return swaps on leveraged loans let credit hedge funds get loan-like exposure without the operational burden of direct loan ownership (assignment processes, agency notices) — a structure that grew substantially alongside the CLO market.

A funded credit derivative structured as a bond — the investor buys the note (paying full principal upfront) and receives an enhanced coupon in exchange for taking on the credit risk of a specified reference entity; a credit event reduces or forfeits the investor's principal.

Real-world exampleCLNs are frequently used by banks to transfer credit risk off their balance sheets while raising funding at the same time — a structure that ties directly back to the CLOs covered in the Fixed Income Products guide.

An agreement to exchange two currencies at a fixed rate on a specified future date — the most straightforward, highest-volume FX derivative, overwhelmingly used by corporates to hedge a known future foreign-currency receivable or payable.

Real-world exampleAn exporter expecting a EUR 10 million receivable in three months will typically sell EUR forward against its own currency today, locking in the rate and removing FX uncertainty from budgeted revenue.

Not to be confused with a cross-currency swap — an FX swap combines a spot FX transaction with an equal and opposite forward transaction in the same currency pair, functioning as a short-term collateralized FX funding tool rather than a directional bet or long-term hedge.

Real-world exampleFX swaps are one of the highest-volume instruments in the entire FX market by turnover, reflecting constant use by banks globally for everyday short-term currency funding, distinct from corporate hedging activity.

An FX forward on a currency that's restricted or not freely convertible (many EM currencies), settled entirely in cash in a freely convertible currency (usually USD) based on the difference between the agreed forward rate and actual spot at maturity — no actual delivery of the restricted currency occurs.

Real-world exampleNDFs on currencies like the Indian rupee, Chinese renminbi (for offshore participants), Brazilian real, and Korean won are heavily used by international investors and corporates hedging exposure without being able to freely trade the underlying currency.