Mastering Interest Rate Risk Strategy

7

Interest rate derivatives

Introduction

Exchange-traded versus OTC

Linear derivatives versus options

Sources of exposure and matching derivatives

INTRODUCTION

Derivatives are financial instruments whose value is derived from the value of an underlying asset. In the case of interest rate derivatives, money market and capital market rates are the underlying assets (see Chapter 4). A firm can use interest rate derivatives to hedge risk (decrease risk) or to speculate (increase risk). I assume that derivatives are used to mitigate risk.

There are various types of interest rate derivatives. Basically, they can be broken down into linear derivatives and options, and into OTC and exchange-traded instruments. The schedule below provides an overview ...