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Exotic Derivatives original pen and ink and watercolour illustration by Rosie Brooks

Exotic Derivatives original pen and ink and watercolour illustration by Rosie Brooks

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Exotic derivatives are a type of financial instrument that have unique or complex features beyond the basic types of financial instruments, such as stocks, bonds, and standard options. Exotic derivatives are generally designed for a specific purpose, and are often customized to meet the specific needs of the buyer or seller. Here are a few examples of exotic derivatives:

  1. Asian options: Options whose payoff is based on the average price of the underlying asset over a period of time, rather than the price at a specific point in time.

  2. Barrier options: Options that have a specific price level or "barrier" that, when reached, either activates or deactivates the option.

  3. Binary options: Options that have a fixed payout if the underlying asset meets a specific condition, or nothing at all if the condition is not met.

  4. Basket options: Options whose underlying asset is a portfolio of assets, rather than a single asset.

  5. Credit default swaps: Contracts in which one party agrees to compensate another party for losses on a specific security or portfolio of securities due to credit events, such as default or bankruptcy.

  6. Swaptions: Options on interest rate swaps, giving the buyer the right to enter into or cancel an interest rate swap contract.

  7. Variance swaps: Derivative contracts that allow the buyer to bet on the future volatility of an underlying asset, rather than its price.

Exotic derivatives can be useful tools for managing specific types of risk or taking advantage of market opportunities. However, due to their complexity and customization, exotic derivatives can be difficult to value, price, and trade, and they may involve significant risks for both buyers and sellers. It's important to have a good understanding of the features, risks, and costs associated with exotic derivatives before engaging in these types of transactions.

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