Exotic Derivatives

Exotic Derivatives

1. They contain specific features that can change the potential outcomes over the life of the contract.

   • Types:
     • Knock Out Trigger: causes the derivative to cease to exist if a predetermined price level is reached
     • Knock In Trigger: causes the derivative to only exist when a predetermined price level is reached
     • Compound: Option of an Option.

2. Uses in hedging

   • 1. Protection from further falls: FLOOR 2. A company requires 'crisis' protection only: Out of the Money Option 3. Even cheaper 'crisis' protection only: Knock Out 4. Benefit from falls: Reveres Floater 5. Benefit from further rises: Leveraged floater

3. Other factors that can influence the use of risk management products

   • Tax/ Transaction Costs/Agency Costs/Reporting