Plain Vanilla
Candlefocus EditorThe term “plain vanilla” is used to describe the simplest version of a financial instrument with no special features or conditions. Traditional options, bonds, interest rate derivatives and other financial instruments are typically referred to as plain vanilla.
When it comes to financial instruments, the distinction between plain vanilla and exotic instruments is an important one. Plain vanilla instruments are associated with low risk, while exotic instruments are associated with high risk. Plain vanilla instruments typically have low transaction costs and liquidity, and therefore tend to be easier to understand and trade in.
The preference for plain vanilla instruments has grown since the 2007 global financial crisis. The crisis revealed the dangerous impact of high-risk financial instruments, and it spurred the creation of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The act seeks to protect consumers and investors from the risks posed by complex, high-risk financial instruments. As a result, a plain vanilla strategy is now seen as the preferred approach for investing.
Generally speaking, plain vanilla instruments are those characterized by simple and transparent terms, such as standard bond or Option contracts, or even traditional assets such as stocks and stock index futures. Plain vanilla instruments typically possess features, such as a regular maturity date and fixed interest or dividend payments that don’t fluctuate with the performance of the underlying assets.
While plain vanilla instruments are associated with low risk, they can still produce good returns when the market is favorable. Investors and financial institutions are increasingly looking to plain vanilla instruments to provide a reliable and safe way to ensure liquidity and protect capital in times of uncertainty. Plain vanilla instruments are also seen as a way to counterbalance high-risk investments such as derivatives and exotic instruments.
Ultimately, plain vanilla instruments provide investors with reliable and safe ways to achieve their short and long-term financial goals. For that reason, it’s increasingly seen as the preferred and safer form of investing in the aftermath of the financial crisis.