Types of derivatives
Types of derivatives

The following Banking & Finance guidance note provides comprehensive and up to date legal information covering:

  • Types of derivatives
  • Swaps
  • Forwards
  • Futures
  • Options

The main types of derivatives are:

  1. swaps

  2. forwards

  3. futures, and

  4. options

This Practice Note explains the key features of each of the above types of derivative.

Swaps

A swap describes a wide variety of derivative transactions. Since their inception in the 1980s, swaps have evolved into a worldwide market encompassing trillions of pounds worldwide in notional value. They are subject to different regulations and laws depending on the market in which they are traded. Swaps are generally documented under the International Swaps and Derivatives Association, Inc. (ISDA) framework (see Practice Note: Derivatives—ISDA documentation framework for more information).

For more information on why parties enter into swaps, see Practice Note: The nature of financial derivatives—Key uses of derivatives.

In a swap, two parties enter into a contract in which they agree to exchange payment streams. Each party to the swap makes regular payments to the other. The payments made under the swap by one party are calculated on a different basis to the payments made by the other party.

At the beginning of the life of a swap, its net value should, in theory, be zero. During the life of the swap, rates will move and the swap will become an asset to one party and a liability to the other. Once a swap becomes an asset to one party, that party is