Contribution of derivatives in the growth of forex markets

Contribution of derivatives in the growth of forex markets.

The tremendous growth of the financial derivatives market and reports of major losses associated with derivative products have resulted in a great deal of confusion about these complex instruments. Are derivatives a cancerous growth that is slowly but surely destroying global financial markets ? Are people who use derivative products irresponsible because they use financial derivatives as part of their overall risk management strategy ?

Thos who oppose financial derivatives fear a financial disaster of tremendous proportions a disaster that could paralyze the world’s financial markets and force governments to intervene to restore stability and prevent massive economic collapse, all at taxpayers’ expense. Critics believe that derivatives create risks that are uncontrollable and not well understood.

People have certain believes about derivatives which hampers the growth of the derivatives market. They are :

Ø  Derivatives are new, complex, high-tech financial products.

Ø  Derivatives are purely speculative, highly leveraged instruments.

Ø  The enormous size of the financial derivatives market dwarfs Bank Capital, Thereby Making Derivatives Trading an Unsafe and Unsound Banking Practice.

Ø  Only large multinational corporations and large banks have a purpose for using derivatives.

Ø  Financial derivatives are simply the latest risk management fad.

Ø  Derivatives take money out of productive processes and never put anything back

Ø  Only risk-seeking organizations should use derivatives

Ø  The risks associated with financial derivatives are new and unknown

Ø  Derivatives ink market participants more tightly together, thereby increasing systematic risks.

This is what some people believe, but it’s not the case.

Actually the financial derivatives have changed the face of finance by creating new ways to understand, measure, and manage financial risks. Ultimately, derivatives offer organizations the opportunity to break financial risks into smaller components and then to buy and sell those components to best meet specific risk-management objectives. Moreover, under a market-oriented philosophy, derivatives allow for the free trading of individual risk components, thereby improving market efficiency. Using financial derivatives should be considered a part of any business’s risk-management strategy to ensure that value-enhancing investment opportunities can be pursued.

Thus, financial derivatives should be considered for inclusion in any corporation’s risk-control arsenal. Derivatives allow for the efficient transfer of financial risks and can help to ensure that value-enhancing opportunities will not be ignored. Used properly, derivatives can reduce risks and increase returns.

Derivatives also have a dark side. It is important that derivatives players fully understand the complexity of financial derivatives contracts and the accompanying risks. Users should be certain that the proper safeguards are built into trading practices and that appropriate incentives are in place so that corporate traders do not take unnecessary risks.

The use of financial derivatives should be integrated into an organization’s overall risk-management strategy and be in harmony with its broader corporate philosophy and objectives. There is no need to fear financial derivatives when they are used properly and with the firm’s corporate goals as guides.