The uses and misuses of derivatives finance essay

An institution might lose liquidity if its credit ratings fall, it experiences sudden unexpected cash outflows or some other event that causes the counterparties to avoid trading with or lending to the institution.

The Amaranth Advisors outcome is a classic case that demonstrates the pitfall of a quantitative approach to risk management. The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions Friedland.

Till now, we have considered swaps in which all things principal, fixed interest, floating interest are denominated in the same currency. They say they are careful to lend only to high credit companies, many of which have proved their resilience during the Latin American financial crisis sparked by the devaluation of the Mexican peso.

But if after some time interest rates are showing greater volatility, and company finds itself at a risky position. For investors, the risks are lower when they sink cash into a dollarized or tightly managed currency like Argentina's peso.

High on their list of candidates is Brazil, which, by some economic measures, bears a passing resemblance to Thailand. Default risk in forward contracts A major drawback of forward contracts is that they are subject to default risk.

It is commonly believed that hedge funds improve the efficiency of the financial markets by introducing liquidity and innovation Hedge fund: This was the job of the funds risks managers to employ scenario analysis based on this past events. Later Maounis said that the conditions in the natural gas market deteriorated and market liquidity dried up so quickly that the fund was unable to unwind its energy positions.

The wider the use of derivatives, the wider the distribution of price information. There is another important use of swaps, i. The buyer and the seller have potential to make unlimited gain or loss The buyer has potential to make unlimited gain while the seller has a potential to make unlimited gain.

He tells that the Amaranth Advisors acted in a very brash manner and took steps being over confident on their quantitative and historic methods of calculating risk, which eventually proved outdated.

Morgan Chase and Citadel Investment Group. By joining all the points we get a straight line. When the bet went in his favour, he could pay back the debt and keep the rest of the profit for Amaranth.

General Accounting Office, May These are not risks created by derivatives; they are risks inherent in business. The question was when.

Criticisms of Derivatives

After its collapse but before liquidating, Amaranth placed restrictions on its investors to withdraw holdings of cash. It is not just the crucial economic question for Brazil, which is enjoying its first sustained period of economic stability for decades, but for the region as a whole.

Derivatives have become an integral part of the financial system in the world's leading economies. Amaranth specialized in the natural gas industry so much that it failed to realise that if it took any incorrect venture at any point in time, it would not have to face severe consequences.

The Uses And Misuses Of Derivatives Finance Essay

The main villain in the current attack has been George Soros, the billionaire financier who is clearly the most colorful and notorious of the speculator lot. The more productive the investment, the higher the rate of growth.

The chart show the volatility Amaranth was facing in Maythis volatility had brought high returns in the past but things then started taking the turn towards the wrong side. The said that there was large scale fluctuations in the value of the fund, which was up sharply in August, would be down 35 percent for the year after the sell-off.

This is likely to encourage continued capital flows from global firms, providing a steady flow of new money.

Purposes and Benefits of Derivatives

Closing Spot price on 29th June is less than the forward price. Further, the price at which the holder may buy or sell as the case may beis known as strike price.


With OTC or floor-traded contracts there are certain complications. When the bet went in his favour, he could pay back the debt and keep the rest of the profit for Amaranth. To manage risk and to increase returns, the companies, the financial and non-financial firms are using forward contracts, future contracts, options, swaps and other various combinations of derivatives.

The arrival of a relatively warm winter did not raise the demand of natural gas as much as in the previous years. They are then inhibited and deterred from directing their capital to efficient uses.Study On The Uses Of A Derivative Market Finance Essay Published: November 27, Investments markets that are connected towards buying and selling of financial instruments and securities are called derivatives market.

use of derivatives in speculation. The county of Orange in California filed for bankruptcy after the county lost more than $1 billion on speculation in the derivatives market.

This trade is a new use of derivatives that differs from the original intentions for the instruments. In this essay we have taken a look at the history of derivatives, the meaning of derivatives, what are the different types of derivatives, what are the benefits and risks of derivatives, and finally what effect did derivatives have on the financial crisis inso we can answer the final question of wither derivatives are weapons of mass.

Study On Barclays Bank And Using Derivatives Finance Essay Barclays is the most prominent financial services providers according to the global perspective. This report critically analyses and discusses the usage and benefits of derivatives which is. The Uses And Misuses Of Derivatives Finance Essay Hedge funds are pools of investment that invest in almost any opportunity in any market where they foresee impressive gains.

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The uses and misuses of derivatives finance essay
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