An exotic derivative, in
finance
Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...
, is a
derivative
In mathematics, the derivative is a fundamental tool that quantifies the sensitivity to change of a function's output with respect to its input. The derivative of a function of a single variable at a chosen input value, when it exists, is t ...
which is more complex than commonly traded "vanilla" products. This complexity usually relates to determination of payoff; see
option style
In finance, the style or family of an option is the class into which the option falls, usually defined by the dates on which the option may be exercised. The vast majority of options are either European or American (style) options. These options ...
.
The category may also include derivatives with a non-standard subject matter - i.e.,
underlying
In finance, a derivative is a contract between a buyer and a seller. The derivative can take various forms, depending on the transaction, but every derivative has the following four elements:
# an item (the "underlier") that can or must be bou ...
- developed for a particular client or a particular market.
[Understanding derivative contracts: types of derivatives](_blank)
The term "exotic derivative" has no precisely defined meaning, being a colloquialism that reflects how common a particular derivative is in the marketplace. As such, certain derivative instruments have been considered exotic when conceived of and sold, but lost this status when they were traded with significant enough volume. Examples of this phenomenon include
interest rate- and
currency-swaps.
As regards
valuation, given their complexity, exotic derivatives are usually
modelled using specialized
simulation- or
lattice-based techniques. Often, it is possible, to "manufacture" the exotic derivative out of standard derivatives.
For example, a
knockout call can be "manufactured" out of standard options; see . This latter approach may then be preferred, and also allows for a benchmark against which the more specialized models may be verified.
See also
*
Exotic option
In finance, an exotic option is an option which has features making it more complex than commonly traded vanilla options. Like the more general exotic derivatives they may have several triggers relating to determination of payoff. An exotic op ...
*
Financial engineering
Financial engineering is a multidisciplinary field involving financial theory, methods of engineering, tools of mathematics and the practice of programming. It has also been defined as the application of technical methods, especially from mathe ...
*
Financial innovation
Financial innovation is the act of creating new financial instruments as well as new financial technologies, institutions, and markets. Recent financial innovations include hedge funds, private equity, weather derivatives, retail-structured pr ...
*
Structured product
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, an ...
References
External links
Understanding derivative contracts: types of derivatives HM Revenue & Customs
His Majesty's Revenue and Customs (commonly HM Revenue and Customs, or HMRC, and formerly Her Majesty's Revenue and Customs) is a Departments of the United Kingdom Government, department of the UK government responsible for the tax collectio ...
Exotic Derivatives and Structured Products Sébastien Bossu,
University of Chicago
The University of Chicago (UChicago, Chicago, or UChi) is a Private university, private research university in Chicago, Illinois, United States. Its main campus is in the Hyde Park, Chicago, Hyde Park neighborhood on Chicago's South Side, Chic ...
Exotic Derivatives, Prof.
Jim Gatheral,
Baruch College
Baruch College (officially the Bernard M. Baruch College) is a public college in New York City, United States. It is a constituent college of the City University of New York system. Named for financier and statesman Bernard M. Baruch, the colle ...
Exotic Equity Derivatives Manual Salomon Smith Barney
Salomon Brothers, Inc., was an American multinational bulge bracket investment bank headquartered in New York City. It was one of the five largest investment banking enterprises in the United States and a very profitable firm on Wall Street du ...
(1998)
Guide to Exotic Credit Derivatives Lehman Brothers
Lehman Brothers Inc. ( ) was an American global financial services firm founded in 1850. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merril ...
A Day in the Life of an Exotic Derivatives Trader quantnet.com
Derivatives (finance)
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