For now let us classify financial markets in terms of cash market and derivative market. Cash market also known as spot market is a market for immediate buying and selling of financial instrument. In contrast, some financial instruments are contracts that specify that the contract holder has an obligation or option to buy or sell something either at or before a future date. Something that is the subject of a contract is an underlying asset or simply inherent. An underlying can be a stock, bond, financial index, interest rate, currency or commodity. Such contracts derive their value from intrinsic value. Hence these contracts are referred to as derivative instruments or simply derivatives. The market in which trading is done is called the derivative market.

Derivative instruments, or simply derivatives, include futures, forwards, options, swaps, caps and floors. A discussion of these important financial instruments as well as their applications in corporate finance and portfolio management is deferred to later chapters.

The primary role of derivative instruments is to provide a transactionally efficient vehicle for protecting investors and issuers against various types of risk. Admittedly, at this early stage it is difficult to see how derivatives are useful for managing risk in an efficient way because often the popular press focuses on how derivatives are abused by corporate treasurers and portfolio managers.

This distinction between notes and bonds is not exact, but is consistent with the common usage of the terms note and bond. In fact, notes and bonds are characterized by whether or not there is an indenture agreement, a legal agreement specifying the terms and any restrictions of borrowing and identifying a trustee to look after the interests of the borrowers. A bond contains an indenture agreement, while a note does not.

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