1. finlogIQ
Knowledge for financial IQ
STRICTLY PRIVATE AND CONFIDENTIAL
Chapter 15
Introduction to other Financial Derivatives
August 2012

2. Chapter summary and outline
This chapter provides an overview of other common financial
derivatives, such as knock-out products, contracts for differences
(CFDs), extended settlement (ES) contracts.
Chapter outline:
• Knock-out products
• Contracts for Differences (CFDs)
• Extended Settlement (ES) contracts
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3. Knock-Out Products
• Are instruments that combine an underlying asset, such as an equity
security, a fixed income security, or other financial assets and an option
– Optionality – pay off profile is “All or nothing”
– Value of the option can become worthless should the price of the underlying
instrument or some other pre-determined reference reach a certain level.
• Diff between product with KO and without KO - holder of KO product will get
no returns (or smaller returns) on the investment should the price of the
underlying asset trade at or beyond the target price level
• Embedded option includes: currencies, commodities, interest rates and
equity products
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4. Contracts for Differences (CFDs)
• Over-the-counter (“OTC”) financial derivative product that is based on an
agreement between two parties (the client and the provider) to settle the
difference in the price of a reference instrument between the inception
transaction and closing transaction.
• In order to mitigate the credit risk from the broker’s perspective:
– Client puts up collateral before he can trade the product
• Traders can initiate long or short positions without actually owning the
underlying reference instrument
• Product has higher risk profile given their leveraged nature
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5. Contracts for Differences (CFDs) - 2
• The chart below shows a typical CFD transaction referencing the stock of a
company
– Trader takes a long position in a stock by just providing a margin plus some
financing and transaction fees to the broker in return for an economic interest in
the stock.
• CFD brokers would allow for this contract to be open indefinitely as long as
the trader maintains adequate margin.
• The trader may close the contract and then settle the price difference in
cash at any time.
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6. Extended Settlement Contracts
• Is a contract between two parties, to buy or sell a specific quantity of a
specific underlying security at a specific price for settlement at a specific
future date
• Commonly known as single stock futures if underlying is an equity security.
• Pricing mechanism: Based on the spot futures parity equation
• In other words it is like a typical futures contract
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