Inflation Derivatives

Inflation derivatives (or inflation-indexed derivatives) refer to over-the-counter and exchange-traded derivatives that are used to transfer inflation risk from one counterparty to another. Typically, real rate swaps also come under this bracket, such as asset swaps of inflation-indexed bonds (government-issued inflation-indexed bonds, such as the Treasury Inflation Protected Securities, TIPS, UK Inflation Linked Gilts, ILGs, French OATei's, Italian BTPei's, German Bundei's and Japanese JGBi's are prominent examples). Inflation swaps are the linear form of these derivatives. They can take a similar form to fixed versus floating interest rate swaps (which are the derivative form for fixed rate bonds), but use a real rate coupon versus floating, but also pay a redemption pickup at maturity (i.e., the derivative form of inflation indexed bonds).

Freight Derivatives

Freight derivatives, which includes Forward Freight Agreement (FFA) and options based on these, are financial instruments for trading in future levels of freight rates, for dry bulk carriers and tankers. These instruments are settled against various freight rate indices published by the Baltic Exchange (for Dry and some Wet contract)& Platt's (some Wet contracts.) FFAs are often traded over-the-counter (through brokers such as ICAPHYDE, Clarkson's Securities, SSY- Simpson, Spence and Young, FIS -Freight Investor Services, GFI, BRS & Tradition-Platou), but screen-based trading is becoming more popular, through various screen. Trades can be given up for clearing by the broker to one of the clearing houses that support such trades. There are three clearing houses for freight: NOS Clearing, LCH.Clearnet & SGX (Singapore). Freight derivatives are primarily used by shipowners and operators, oil companies, trading companies and grain houses as tools for managing freight rate risk. Recently with Commodities now standing at the forefront of international economics; the large financial trading house, including banks and hedgefunds have entered the market.

Dry Freight or Dry-Bulk FFAs

The Baltic Exchange, Baltic Dry Index which measures the cost for shipping goods like iron ore and grains, doubled over the past 12 months and has risen more than fourfold since 2006.
The trading volume of dry freight derivatives, a market estimated to be worth about $200 billion in 2007, grew as those needing ships attempted to contain their risks and investment banks and hedge funds looked to make profits from speculating on price movements. At the close of the 2007 financial year, the number of traded lots on dry FFAs doubled the derived physical product.

Derivatives Definition

Derivatives are financial instruments whose value changes in response to the changes in underlying variables. The main types of derivatives are futures, forwards, options, and swaps.

The main use of derivatives is to reduce risk for one party. The diverse range of potential underlying assets and pay-off alternatives leads to a huge range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) — see inflation derivatives — or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the pay-offs.