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What Is Derivatives Law?

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  • Written By: C. Daw
  • Edited By: O. Wallace
  • Last Modified Date: 20 November 2016
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Derivatives law is an area of law that deals with the rules and regulations of derivatives. These laws are closely connected to the principles of contract law. To practice under the area of derivatives law, one should have a vast understanding of certain business principles like insolvency, netting and set-offs. A lawyer who practices this type of law will advise their client on the rules that will affect them and their financial dealings. They will help to ensure that the proper documentation is completed when dealing with them, like credit default swaps, and that all financial regulations are followed.

Understanding what derivatives are is vital if one wants to understand the practice of derivatives law. They are financial tools whose values are directly dependent on underlying investments or variables. Some of these underlying investments or variables are financial tools like interest rates, stock options, swaps, and the price of other financial investments. It is important when businesses and individuals are dealing with these types of exchanges that the appropriate rules and regulations are followed, as well as the right paperwork completed as required. To be certain this legal process is followed, many people choose to hire a lawyer who specializes in derivatives law. There are two major categories of derivatives law contracts, which are over-the-counter derivatives and exchange-traded derivatives.

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An over-the-counter (OTC) derivative is traded between two people directly without any other financial tools being used, like an exchange or other intermediary. They are contracts that fall under the outlined master agreement that has been made. Common types of OTC’s are swaps, forward rate agreements, and different types of options. An option is an agreement that gives the holder the choice to buy or sell a specified financial security, but they are not obligated to buy or sell the security. Many of these swaps fall under regulations of The International Swap and Derivatives Association (ISDA) Master Agreement.

The other type of derivative is an exchange-traded derivative (ETD). These types are unlike the OTC kind and they are traded through a specialized exchange. Some of these exchanges specialize in offers to swap for various financial tools. These contracts can include future calls or put options. A call option allows the holder the choice to buy the security at a predetermined price, but not the obligation to buy, whereas a put option allows the holder the option to sell the security at a predetermined price, but not the obligation to sell.

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