CFM11006 - Understanding derivative contracts: introduction

Overview

This section of the guidance is dealt with under the headings, ‘What are derivatives?’ and ‘Managing risk’

• What are derivatives? ( CFM11020+). This briefly explains what derivatives are and the basic types of derivative contract. It discusses what documentation you might expect to see when a company has entered into a derivative contract. It also gives an overview of how dealings in derivatives are regulated and how different types of derivative contract are defined in the Financial Services and Markets Act 2000.
• Managing risk ( CFM11200+). This identifies the main areas of financial risk to which companies are exposed and how they may use derivatives to hedge those risks. Other reasons why companies may be involved with derivative contracts are also mentioned.

As with other branches of corporate finance, there is a certain amount of jargon which has grown up around the use of derivatives. Some of the most frequently used terms are summarised in a glossary.

• Readers of small and medium-sized companies’ accounts will rarely see entries relating to the use of derivatives.
• Large groups of companies are likely to use derivative contracts much more frequently. Before assessing the tax risks, Inland Revenue staff will need to be familiar with how derivative contracts work and why a particular group of companies is using them.
• This guidance is not written from the point of view of the banks and other financial institutions that sell derivative products. But the material in this volume may be a helpful supplement to the Banking Manual.

For details of the other guidance relating to derivative contracts, see CFM11007.