Anexotic derivative, infinance, is aderivative which is more complex than commonly traded "vanilla" products. This complexity usually relates to determination of payoff;[1] seeoption style.The category may also include derivatives with a non-standard subject matter - i.e.,underlying - developed for a particular client or a particular market.[2]
The term "exotic derivative" has no precisely defined meaning, being a colloquialism that reflects how common a particular derivative is in the marketplace. As such, certain derivative instruments have been considered exotic when conceived of and sold, but lost this status when they were traded with significant enough volume. Examples of this phenomenon includeinterest rate- andcurrency-swaps.
As regardsvaluation, given their complexity, exotic derivatives are usuallymodelled using specializedsimulation- orlattice-based techniques. Often, it is possible, to "manufacture" the exotic derivative out of standard derivatives.[3] For example, aknockout call can be "manufactured" out of standard options; seeBarrier option § Valuation. This latter approach may then be preferred, and also allows for a benchmark against which the more specialized models may be verified.
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