An interest rate derivative is a derivative where the underlying asset is the right to pay or receive a (usually notional) amount of money at a given interest rate.
The interest rate derivatives market is the largest derivatives market in the world. Measuring the size of the market is difficult because trading in the interest rate derivative market is largely done over-the-counter.
These are the basic building blocks for most interest rate derivatives and can be described as vanilla (simple, basic derivative structures, usually most liquid) products:
- Interest rate swap (fixed-for-floating)
- Interest rate cap or Floor
- Interest rate swaption
- Bond Option
- Forward rate agreement
- Interest rate future
- Money market instruments
- Cross currency swap
The next intermediate level is a quasi-vanilla class of (fairly liquid) derivatives, examples of which are:
These structures are popular for investors with customized cashflow needs or specific views on the interest rate movements (such as volatility movements or simple directional movements).
