Barclays 2010 Annual Report Download - page 215

14 Derivative financial instruments
The Group’s objectives and policies on managing the risks that arise in connection with derivatives, including the policies for hedging, are discussed in
the Risk Management section on pages 66 to 142.
The use of derivatives and their sale to customers as risk management products are an integral part of the Group’s trading activities. These instruments
are also used to manage the Group’s own exposure to fluctuations in interest, exchange rates and commodity and equity prices as part of its asset and
liability management activities.
Barclays Capital manages the trading derivatives book as part of the market risk book. This includes foreign exchange, interest rate, equity, commodity
and credit derivatives. The policies regarding market risk management are outlined in the market risk management section on pages 118 to 125.
The Group’s exposure to credit risk arising from derivative contracts, as well as the Group’s participation in exchange traded and over the counter
derivatives markets are outlined in the Credit risk section on page 110.
Derivative instruments are contracts whose value is derived from one or more underlying financial instruments or indices defined in the contract.
They include swaps, forward rate agreements, futures, options and combinations of these instruments and primarily affect the Group’s net interest
income, net trading income, net fee and commission income and derivative assets and liabilities. Notional amounts of the contracts are not recorded
on the balance sheet.
Foreign exchange derivatives
The Group’s principal exchange rate related contracts are forward foreign exchange contracts, currency swaps and currency options. Forward foreign
exchange contracts are agreements to buy or sell a specified quantity of foreign currency, usually on a specified future date at an agreed rate. A currency
swap generally involves the exchange, or notional exchange, of equivalent amounts of two currencies and a commitment to exchange interest
periodically until the principal amounts are re-exchanged on a future date.
Currency options provide the buyer with the right, but not the obligation, either to purchase or sell a fixed amount of a currency at a specified
exchange rate on or before a future date. As compensation for assuming the option risk, the option writer generally receives a premium at the start
of the option period.
Interest rate derivatives
The Group’s principal interest rate related contracts are interest rate swaps, forward rate agreements, basis swaps, caps, floors and swaptions. Included
in this product category are transactions that include combinations of these features. An interest rate swap is an agreement between two parties to
exchange fixed rate and floating rate interest by means of periodic payments based upon a notional principal amount and the interest rates defined in
the contract. Certain agreements combine interest rate and foreign currency swap transactions, which may or may not include the exchange of principal
amounts. A basis swap is a form of interest rate swap, in which both parties exchange interest payments based on floating rates, where the floating rates
are based upon different underlying reference indices. In a forward rate agreement, two parties agree a future settlement of the difference between an
agreed rate and a future interest rate, applied to a notional principal amount. The settlement, which generally occurs at the start of the contract period,
is the discounted present value of the payment that would otherwise be made at the end of that period.
Credit derivatives
The Group’s principal credit derivative-related contracts include credit default swaps and total return swaps. A credit derivative is an arrangement
whereby the credit risk of an asset (the reference asset) is transferred to the seller of protection.
A credit default swap is a contract where the protection seller receives premium or interest-related payments in return for contracting to make payments
to the protection buyer upon a defined credit event. Credit events normally include bankruptcy, payment default on a reference asset or assets, or
downgrades by a rating agency.
A total return swap is an instrument whereby the seller of protection receives the full return of the asset, including both the income and change in the
capital value of the asset. The buyer of the protection in return receives a predetermined amount.
Equity derivatives
The Group’s principal equity-related contracts are equity and stock index swaps and options (including warrants, which are equity options listed on an
exchange). An equity swap is an agreement between two parties to exchange periodic payments, based upon a notional principal amount, with one
side paying fixed or floating interest and the other side paying based on the actual return of the stock or stock index. An equity option provides the buyer
with the right, but not the obligation, either to purchase or sell a specified stock, basket of stocks or stock index at a specified price or level on or before
a specified date. The Group also enters into fund-linked derivatives, being swaps and options whose underlyings include mutual funds, hedge funds,
indices and multi-asset portfolios.
Commodity derivatives
The Group’s principal commodity-related derivative contracts are swaps, options, forwards and futures. The main commodities transacted are base
metals, precious metals, oil and oil-related products, power and natural gas.
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