What is a Derivative?

In short, a derivative is a contractual relationship established by two (or more) parties

where payment is based on (or "derived" from) some agreed-upon benchmark. Since
individuals can "create" a derivative product by means of an agreement, the types of
derivative products that can be developed are limited only by the human imagination.
Therefore, there is no definitive list of derivative products. Some common financial
derivatives, however, are described at the end of this brochure (See, Description of
Common Financial Derivatives ).
Description of Common Financial Derivatives:

Options. An Option represents the right (but not the obligation) to buy or sell a
security or other asset during a given time for a specified price (the "Strike "
price). An Option to buy is known as a "Call ," and an Option to sell is called a
"Put. " You can purchase Options (the right to buy or sell the security in question)
or sell (write) Options. As a seller, you would become obligated to sell a security
to, or buy a security from, the party that purchased the Option. Options can be
either "Covered " or "Naked ." In a Covered Option, the contract is backed by
the asset underlying the Option, e.g. , you could purchase a Put on 300 shares
of the ABC Corp. that you now own. In a Naked Option, the contract is not
backed by the security underlying the Option. Options are traded on organized
exchanges and OTC.

Forward Contracts. In a Forward Contract, the purchaser and its counterparty

are obligated to trade a security or other asset at a specified date in the future.
The price paid for the security or asset is agreed upon at the time the contract is
entered into, or may be determined at delivery. Forward Contracts generally are
traded OTC.

Futures. A Future represents the right to buy or sell a standard quantity and
quality of an asset or security at a specified date and price. Futures are similar to
Forward Contracts, but are standardized and traded on an exchange, and are
valued, or "Marked to Market " daily. The Marking to Market provides both
parties with a daily accounting of their financial obligations under the terms of the
Future. Unlike Forward Contracts, the counterparty to a Futures contract is the
clearing corporation on the appropriate exchange. Futures often are settled in
cash or cash equivalents, rather than requiring physical delivery of the underlying
asset. Parties to a Futures contract may buy or write Options on Futures.

Swaps. A Swap is a simultaneous buying and selling of the same security or obligation.
Perhaps the best-known Swap occurs when two parties exchange interest payments
based on an identical principal amount, called the "notional principal amount."
Think of an interest rate Swap as follows: Party A holds a 10-year $10,000 home equity
loan that has a fixed interest rate of 7 percent, and Party B holds a 10-year $10,000
home equity loan that has an adjustable interest rate that will change over the "life" of
the mortgage. If Party A and Party B were to exchange interest rate payments on their
otherwise identical mortgages, they would have engaged in an interest rate Swap.
Interest rate swaps occur generally in three scenarios. Exchanges of a fixed rate for a
floating rate, a floating rate for a fixed rate, or a floating rate for a floating rate.
A capital market is a market for securities (debt or equity), where business enterprises
(companies) and governments can raise long-term funds. It is defined as a market in which
money is provided for periods longer than a year,[1][dead link] as the raising of short-term funds
takes place on other markets (e.g., the money market). The capital market includes the stock
market (equity securities) and the bond market (debt). Financial regulators, such as the UK's
Financial Services Authority (FSA) or the U.S. Securities and Exchange Commission (SEC),
oversee the capital markets in their designated jurisdictions to ensure that investors are
protected against fraud, among other duties.

The primary market is that part of the capital markets that deals with the issuance of
new securities. Companies, governments or public sector institutions can obtain funding
through the sale of a new stock or bond issue. This is typically done through a syndicate
of securities dealers. The process of selling new issues to investors is called
underwriting. In the case of a new stock issue, this sale is an initial public offering (IPO).
Dealers earn a commission that is built into the price of the security offering, though it
can be found in the prospectus. Primary markets creates long term instruments through
which corporate entities borrow from capital market.
The secondary market, also called aftermarket, is the financial market where
previously issued securities and financial instruments such as stock, bonds, options,
and futures are bought and sold.[1]. Another frequent usage of "secondary market" is to
refer to loans which are sold by a mortgage bank to investors such as Fannie Mae and
Freddie Mac.
The term "secondary market" is also used to refer to the market for any used goods or
assets, or an alternative use for an existing product or asset where the customer base is
the second market (for example, corn has been traditionally used primarily for food
production and feedstock, but a "second" or "third" market has developed for use in
ethanol production).