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From the economic point of view, financial derivatives are cash flows that are conditioned stochastically and discounted to present value. The market risk inherent in the underlying asset is attached to the financial derivative through contractual agreements and hence can be traded separately. [11] The underlying asset does not have to be acquired.
The XVA of Financial Derivatives: CVA, DVA and FVA Explained. Palgrave Macmillan. ISBN 978-1137435835. Ignacio Ruiz (2015). XVA Desks - A New Era for Risk Management. Palgrave Macmillan UK. ISBN 978-1-137-44819-4. Antoine Savine and Jesper Andreasen (2021). Modern Computational Finance: Scripting for Derivatives and XVA. Wiley. ISBN 978-1119540786.
The difference is explained as follows: By construction, the value of the derivative will (must) grow at the risk free rate, and, by arbitrage arguments, its value must then be discounted correspondingly; in the case of an option, this is achieved by "manufacturing" the instrument as a combination of the underlying and a risk free "bond"; see ...
This result is the "Binomial Value". It represents the fair price of the derivative at a particular point in time (i.e. at each node), given the evolution in the price of the underlying to that point. It is the value of the option if it were to be held—as opposed to exercised at that point.
A Credit valuation adjustment (CVA), [a] in financial mathematics, is an "adjustment" to a derivative's price, as charged by a bank to a counterparty to compensate it for taking on the credit risk of that counterparty during the life of the transaction. "CVA" can refer more generally to several related concepts, as delineated aside.
As OTC instruments, interest rate swaps (IRSs) can be customised in a number of ways and can be structured to meet the specific needs of the counterparties. For example: payment dates could be irregular, the notional of the swap could be amortized over time, reset dates (or fixing dates) of the floating rate could be irregular, mandatory break clauses may be inserted into the contract, etc.
A variance swap is an over-the-counter financial derivative that allows one to speculate on or hedge risks associated with the magnitude of movement, i.e. volatility, of some underlying product, like an exchange rate, interest rate, or stock index.
An equity swap is a financial derivative contract (a swap) where a set of future cash flows are agreed to be exchanged between two counterparties at set dates in the future. [1] The two cash flows are usually referred to as "legs" of the swap; one of these "legs" is usually pegged to a floating rate such as LIBOR. This leg is also commonly ...