7.1 Introduction
The 1980s and 1990s witnessed a rapid growth in the volume and a variety of use of derivative instruments.This is related to the increased importance of financial markets around the world, securitization of previously non-tradable financial instruments and obligations, and the need for borrowers and investors to hedge against volatility in the securities markets.
Derivative instruments are financial claims with value based on that of the underlying securities.Therefore a change in the value of an underlying security (T-bond)is expected to be accompanied by a similar change in the value of the related derivative instrument (T-bond future).Derivatives are originated and traded both on organized exchanges and over-the-counters.Exchange traded instruments have an aggregate value that is somewhat less than over-the-counter traded instruments.
Interest rate futures account for more than 65% of the value of exchange traded derivatives.These include short-term interest rate instruments and long-term instruments (bond futures).Short-term instruments account for 94% of all interest rate futures.In addition to these two interest rate futures, two other financial futures occupy this field.These include currency futures and stock market index futures.
Exchange-traded instruments also include interest rate options, currency options, and stock market index options.The largest of these in value are the interest rate options.
Over-the-counter instruments include interest rate swaps, currency swaps, and other swap-related derivatives (caps, collars, floors, and swaps).
The value of exchange-traded instruments has been growing explosively, almost doubling every two years.Similarly, over-the-counter traded instruments have been growing rapidly, but a lesser rate than instruments traded on organized exchanges.