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SECURITIES |
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DERIVATIVES
Financial derivatives are contracts that derive their value from the performance of an underlying financial asset, such as publicly traded securities and foreign currencies. They are used as hedging instruments to protect against changes in asset value. There are many kinds of derivatives including futures, options and swaps. Futures and options contracts are traded on the floors of exchanges. Swaps are over-the-counter, privately negotiated agreements between two parties. The number of futures contracts traded on U.S. exchanges more than tripled between 2001 and 2006, from 629 million in 2001 to 2.0 billion in 2006.
Credit derivatives are contracts that lenders, large bondholders and other investors can purchase to protect against credit risks. One such derivative, credit default swaps (CDSs), protects lenders when companies don't pay their debt. The swaps are contracts between two parties: the buyer of the credit protection and the seller, i.e., the firm offering protection. Their workings are similar to insurance. Under the contract the buyer makes payments to the seller over an arranged period of time. The seller pays only if there is a default or other credit problem. Either the buyer or the seller can sell the contract to a third party. These instruments are often valued based on computer models; the actual value at settlement might be quite different from the modeled value. Banks, insurance companies and hedge funds create and trade the CDSs, which are largely unregulated and have experienced enormous growth in recent years. According to the International Swaps and Derivatives Association, CDSs grew from $631 billion in 2000 to $46 trillion by the first half of 2007. Bond insurers now write coverage for CDSs in addition to their traditional bond insurance coverage.
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CREDIT DEFAULT SWAPS MARKET, 2000-2007 (1)
($ billions)
Year |
Amount outstanding |
Percent change |
| 2000 | $631.5 | NA |
| 2001 | 918.9 | 45.5% |
| 2002 | 2,191.6 | 138.5 |
| 2003 | 3,779.4 | 72.5 |
| 2004 | 8,422.3 | 122.8 |
| 2005 | 17,096.1 | 103.0 |
| 2006 | 34,422.8 | 101.3 |
| 2007 (2) | 45,464.5 | 32.1 |
(1) Notional principal value outstanding.
(2) First half.
Source: International Swaps and Derivatives Association. |
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NUMBER OF FUTURES CONTRACTS TRADED ON U.S. EXCHANGES, 1997-2006
(millions)
Year |
Interest rate |
Agricultural commodities |
Energy products |
Foreign currency |
Equity indices |
Precious metals |
Non-precious metals |
Other |
Total |
| 1997 | 244.6 | 74.9 | 52.9 | 26.6 | 25.8 | 15.4 | 2.4 | 1.1 | 443.7 |
| 1998 | 279.2 | 73.3 | 63.8 | 27.0 | 42.4 | 13.8 | 2.5 | 1.2 | 503.2 |
| 1999 | 240.7 | 73.0 | 75.1 | 23.7 | 46.7 | 14.5 | 2.9 | 1.3 | 477.9 |
| 2000 | 248.7 | 73.2 | 73.1 | 19.4 | 62.8 | 10.2 | 2.8 | 1.3 | 491.5 |
| 2001 | 342.2 | 72.3 | 72.5 | 21.7 | 107.2 | 9.6 | 2.9 | 0.7 | 629.2 |
| 2002 | 418.8 | 79.2 | 92.1 | 23.5 | 221.5 | 12.4 | 2.9 | 1.0 | 851.3 |
| 2003 | 509.6 | 87.9 | 91.9 | 33.6 | 296.7 | 16.9 | 3.2 | 3.1 | 1,043.0 |
| 2004 | 704.2 | 101.8 | 109.5 | 51.1 | 330.0 | 21.3 | 3.3 | 2.9 | 1,324.0 |
| 2005 | 870.5 | 116.4 | 140.5 | 84.8 | 406.8 | 23.4 | 4.0 | 6.5 | 1,652.9 |
| 2006 | 1,034.6 | 157.5 | 190.9 | 114.0 | 500.4 | 34.3 | 3.3 | 1.1 | 2,043.9 |
| Source: Futures Industry Association; Securities Industry and Financial Markets Association. |
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NUMBER OF OPTIONS CONTRACTS TRADED ON U.S. EXCHANGES, 1997-2006
(millions)
| - The number of options contracts traded on U.S. exchanges increased by 35.1 percent in 2006, compared with an increase of 27.3 percent in 2005 and 30.3 percent in 2004.
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GLOBAL DERIVATIVES MARKET, 1997-2006 (1)
($ billions)
Year |
Exchange-traded |
Over-the-counter (OTC) |
Total |
| 1997 | $12,202 | $29,035 | $41,237 |
| 1998 | 13,932 | 80,318 | 94,250 |
| 1999 | 13,553 | 88,202 | 101,755 |
| 2000 | 14,278 | 95,199 | 109,477 |
| 2001 | 23,764 | 111,178 | 134,942 |
| 2002 | 23,816 | 141,665 | 165,481 |
| 2003 | 36,740 | 197,167 | 233,907 |
| 2004 | 46,592 | 257,894 | 304,486 |
| 2005 | 57,787 | 297,670 | 355,457 |
| 2006 | 70,442 | 415,183 | 485,625 |
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(1) Notional principal value outstanding. Data after 1998 not strictly comparable to 1997 data.
Source: Bank for International Settlements. |
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