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 rose from 629 million in 2001 to 2.9 billion in 2008. After falling to 2.3 billion in 2009, the number of contracts rose to 2.8 billion in 2010 and 3.1 billion in 2011.

Credit derivatives are contracts that lenders, large bondholders and other investors can purchase to protect against credit risks. One such derivative, credit default swaps (CDS), protects lenders when companies do not 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. Banks, insurance companies and hedge funds create and trade the CDSs. Bond insurers now issue protection in the form of CDSs in addition to their traditional bond insurance coverage. The CDS market, which is largely unregulated, experienced enormous growth from 2004 to 2007 but declined in the four subsequent years.

According to surveys by the Bank for International Settlements (BIS), the over-the-counter CDS market dropped from $58.2 trillion in 2007 to $29.9 trillion in 2010, based on data from The Group of Ten (G10), made up of eleven countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the U.K. and the U.S.) which work together on economic matters. The latest BIS survey, which now also includes Spain and Australia, puts the market at $28.6 billion in 2011.

 

CREDIT DEFAULT SWAPS MARKET, 2004-2011 (1)

($ billions, end of year)

Year Amount outstanding (2) Percent change
2004 $6,395.7 NA
2005 13,908.3 117.5%
2006 28,650.3 106.0
2007 58,243.7 103.3
2008 41,882.7 -28.1
2009 32,692.7 -21.9
2010 29,897.6 -8.5
2011 (3) 28,633.0 -4.2

(1) Based on over-the-counter derivatives data from the G10 countries (11 countries).
(2) Notional principal value outstanding. Notional value is the underlying (face) value.
(3) Beginning in December 2011, the BIS added Spain and Australia to the survey, bringing the number of countries to 13.

NA=Data not available.

Source: Bank for International Settlements (BIS).

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NUMBER OF FUTURES CONTRACTS TRADED ON U.S. EXCHANGES, 2002-2011

(millions)

Year Interest rate Agricultural commodities Energy products Foreign currency Equity indices Precious metals Non- precious metals Other Total
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
2007 1,333.1 193.3 240.9 143.0 659.3 44.1 3.8 19.2 2,644.6
2008 1,213.1 215.4 285.9 155.8 904.9 56.2 4.6 13.0 2,852.5
2009 854.6 196.6 313.1 156.3 744.7 48.8 6.4 4.8 2,328.1
2010 1,123.0 239.5 350.6 229.1 740.6 63.8 10.4 3.1 2,764.8
2011 1,277.6 265.9 374.1 231.6 813.9 76.3 12.6 1.0 3,056.5

Source: Futures Industry Association; Securities Industry and Financial Markets Association.

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NUMBER OF OPTIONS CONTRACTS TRADED ON U.S. EXCHANGES, 2002-2011

(millions)

Year Equity Stock index Foreign currency Interest rate Futures Total
2002 679.4 100.6 0.4 (1) 213.1 993.6
2003 789.2 118.3 0.3 0.1 221.7 1,129.5
2004 1032.4 149.3 0.2 0.1 289.2 1,471.2
2005 1,292.2 211.8 0.2 0.1 368.0 1,872.2
2006 1,717.7 310.0 0.1 0.2 501.5 2,529.4
2007 2,379.1 267.9 2.8 (1) 583.6 3,233.5
2008 3,284.8 292.2 5.6 (1) 518.9 4,101.5
2009 3,367.0 244.1 1.6 (1) 374.5 3,987.1
2010 3,610.4 287.8 0.8 (1) 457.3 4,356.4
2011 4,224.6 337.5 0.6 (1) 499.6 5,062.3

(1) Fewer than 50,000 interest rate contracts traded.

Source: Options Clearing Corporation; Futures Industry Association; Securities Industry and Financial Markets Association.

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  • The number of options contracts traded on U.S. exchanges rose 16.2 percent in 2011, following a 9.3 percent increase in 2010, to the highest level in the 32 years of record-keeping.

 

GLOBAL DERIVATIVES MARKET, 2002-2011 (1)

($ billions)

Year Exchange-traded Over-the-counter Total
2002 $23,831 $141,665 $165,497
2003 36,701 197,167 233,867
2004 46,521 258,628 305,149
2005 57,258 299,261 356,519
2006 69,399 418,131 487,530
2007 79,088 585,932 665,020
2008 57,744 598,147 655,892
2009 73,118 603,900 677,017
2010 67,946 601,048 668,995
2011 58,331 647,762 706,693

(1) Notional principal value outstanding. Notional value is the underlying (face) value.

Source: Bank for International Settlements; Securities Industry and Financial Markets Association.

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