Exotics

An exotic derivative is a derivative that cannot be created by putting together option and forward contracts. Instead the pay off of exotics is a complicated function of one or many underlyings.When procter and Gamble lost $ 160 million on derivatives in 1994 the main culprit was an exotic swap.The amounts P & G had to pay on the swap depended on the five year Treasury note yield and the price of the 30 year Treasury bond.Another example of an exotic derivative is a binary option.which pays a fixed amount if some condition is met. For instance, a binary option might pay $ 10 million if before a given future date one of the three largest banks has defaulted on its debt.