Why do so many derivative products exist?

[investalot]

I’m right now going through derivative products for fixed income risk exposure management. I must be missing something since it appears to me that there is plenty of redundancy with all the derivatives. For instance, why have a cap and floor when you could just write or buy options on the asset. I can explain aways some of the derivatives by the specific needs of certain investors, but I still strongly feel that there is a lot of over lap and unnecessary products that can simply achieve same objective through already available means.

Here is another example: what need could there possibly be for an option on a future contract? Seriously, why create a derivative with the underlying being another derivative. First off, I can’t begin to navigate the complexity of valuing such a contract. Second, at what point does this “make a derivative for anything” method just go overboard?

Once again, I truly hope I’m just missing something since these finance guys must be very sophisticated people when creating such instruments. But in that case, I would love to be educated in the rationale for this.

[S2000magician]

@investalot

I’m right now going through derivative products for fixed income risk exposure management. I must be missing something since it appears to me that there is plenty of redundancy with all the derivatives. For instance, why have a cap and floor when you could just write or buy options on the asset.

Caps and floors apply to interest rates; to what asset are you referring?

@investalot

I can explain aways some of the derivatives by the specific needs of certain investors, but I still strongly feel that there is a lot of over lap and unnecessary products that can simply achieve same objective through already available means.

Here is another example: what need could there possibly be for an option on a future contract?

The need is that sometimes you don’t know whether you’ll want to enter into a futures contract or not. The option allows you to fix the price of the futures today, eliminating the risk that the price will change should you want to enter into it later.

@investalot

Seriously, why create a derivative with the underlying being another derivative.

Why not? A derivative is an asset, just like any other asset.

@investalot

First off, I can’t begin to navigate the complexity of valuing such a contract. Second, at what point does this “make a derivative for anything” method just go overboard?

Never.

[birdman12345]

Only one reason for any and all derivatives, to make money for the exchanges and banks by increasing the trading volume.

[Flashback]

It’s funny to know that you may use derivatives for tax avoidance as well. Unfortunately, there are no derivatives in my country. Otherwise, it would be the national sport.