Derivatives and Risk



Derivatives and Risk

Answr1)

Recent growth in the credit derivative proposes that participants in the market find this instrument very useful in order to manage their risk. While derivatives are used as a means to manage risk, they may also prove to be an important source of risk, and ultimately of factors causing the instability of financial markets. Basically, derivatives are subject to the same risks that the financial instruments described as more traditional. However, by the nature, risks associated with them are manifested differently and in the case of certain instruments, can be amplified. For example, the positions high leverage may increase the risks associated with the use of derivative instruments point destabilize financial markets. The result is a threat of systemic risk (Sundaresan S., 1991).

Similarly, the complexity of some of these instruments, the volume of transactions and lack of transparency may increase the risk of loss. In some cases, losses can be generated within days if not within hours. The pay system, where it is closely linked to performance, may encourage the staff of the trading floor in an excessive risk taking.

Hedging & Speculation in Derivative Applications

Hedging aims to reduce or eliminate the risk of contracting parties associated with the underlying asset. In these operations, one side assumes the risk and is distributed. In any speculative operations, the contracting parties have a prior risk associated with the underlying asset and the contract was due solely to the purpose of financial gain as opposed to its counterpart.

The risks that a company is exposed we can highlight:

Movements in prices of raw materials.

Changes in exchange rates of currencies in which these materials are known.

Oscillations in the price of energy are needed to process these materials.

Changes in the exchange rate of its own currency (if it increases, will reduce their competitiveness abroad, the opposite occurring if it drops, if expressed in an indirect way)

Changes in interest rates in your country, affecting the cost of debt and, possibly, its sales revenue.

Changes in interest rates in other countries, affecting its competitors, and therefore, the sales performance of the company, etc.

The effect of market and environmental risks on companies has been increasing while the global financial environment becomes more uncertain. However, it was not until recently when managers have begun to consider the management of these risks, in order to limit potential losses and stabilize business flows (Eilrich F, Ward C., 1996).

Hedging and Speculation Risk by Royal Dutch Shell

Hedging risk increased cost of raw materials purchasing futures contracts. The Shell a manufacturer of gasoline - has carried out its sale in January for delivery in March. Forward transaction is concluded to 1000 barrels of gasoline at a price of £ 35 per barrel, Oil production for the party's plan to buy gasoline in March. The current oil price of £ 18 per barrel suits the company, but there are fears that at the time of delivery of petrol, oil prices will rise, resulting in any ...