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Analysis of Currency Derivatives and Interest Rate Derivatives Market

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A derivative is a financial instrument whose value depends upon that of another asset. A derivative may be used as a tool to either take a position on the underlying asset or to transfer or hedge risk. Derivatives can either be traded on organized exchanges or negotiated privately between two parties. Privately negotiated trades, known as over-the-counter or OTC trades, allow parties to customize features of the derivative to serve the specific needs of the users. OTC trading can be conducted through voice execution or an electronic trading platform, with dealers typically making the market for customers. By contrast, exchange traded contracts are more standardized and there is often an order book system that matches bids and offers.

An interest rate derivative (IRD) is an agreement to exchange payments based on different rates over a specified period of time. In its most common form, the single currency interest rate swap, parties agree to exchange payments periodically based on a fixed interest rate agreed upon at the outset of the transaction and a floating interest rate based on a specified reference index.8 The floating rate reset dates and the payment intervals for the contract are also determined at the outset. The notional amount of the contract is used only to calculate the periodic payments due between parties and is not exchanged. As an example,

US dollar interest rate swaps typically reference the 3-month LIBOR index, and participants usually pay the floating payments at 3-month intervals and fixed payments at 6-month intervals over the life of the contract.

Exchange-traded interest rate derivatives are generally highly-standardized products with fixed terms for most of the contract features. The OTC products in our dataset allow for customization of contract terms, but are still considered fairly standard because their structures provide for relatively straightforward risk modeling. More exotic structures generally entail a combination of several simple interest rate product structures, or additional embedded options where the interplay of the risks becomes more complex. The market for such products is less liquid because they are more tailored and because hedging the risks and the unwinding of positions can be costlier. Exotic product structures are estimated to make up around 2% of the OTC interest rate derivatives market, 12 and are not included in our dataset because they are not eligible for electronic matching.

Number of Pages of Project Report: 66
Package Includes: Synopsis/Project Proposal + Project Report
Project Format: Document (.doc)

Table of Contents of Project Report:
3.1 Introduction to derivatives
3.2 Derivatives defined
3.3 Products, Participants and Functions
3.4 Types of Derivatives
3.6 Development of exchange-traded Derivatives
3.7 Exchange-traded vs. OTC derivatives markets
3.8 Derivatives market in India

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