# What kind of entities use exotic derivatives, and do they serve any purpose other than hedging risk?

I work in a sell-side bank in derivatives modeling. My work involves modeling and pricing of exotic derivatives and I often wonder who are the buyers of these products.

From my research, I found that its generally hedge funds or entities on the buy-side that want to buy these exotic derivatives. However I don't understand it in depth in the sense that are derivatives used to speculate or take a position, or they are used to hedge a certain position.

For example, I have questions like, is it reasonable to assume that funds that employ systematic strategies wouldn't use exotic or complex derivatives while it would only be the discretionary funds that would use such exotics.

Could someone take an example of a derivative and explain how a buy-side entity would lets say take a position and how using a derivative would make sense for them in that context. Or you could point me towards some online reading material or resource where I can learn about this.

• Honestly it’s such a broad question, given that you haven’t even defined an asset class or geography. A good start would be to ask the business people who are using your models. – dm63 Jun 21 at 12:28
• @dm63 Lets say we are talking about interest rate exotics in the US markets. I dont get to interact a lot with the business end but I can try. – qwerty_uiop Jun 21 at 12:30
• Therein lies an issue - there ought to be healthy interaction between those building models and those using them. If you can name a few types of exotics I can give you an answer. – dm63 Jun 21 at 12:40

Example 1. Buy-side buys notes whose coupon is $$\min(\max(\rm{gearing}*(\rm{index}_1-\rm{index}_2),\rm{maximum}),\rm{minimum})$$. Their motivation is often their view that the sell side is pricing these too cheap.