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In the light of recent examples of banks and companies making heavy losses from using derivatives, evaluate the risks and benefits of derivatives contracts - Essay Example

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Investment managers and banks use derivatives to enhance better utilization of information, management of risks and reduction of the…
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In the light of recent examples of banks and companies making heavy losses from using derivatives, evaluate the risks and benefits of derivatives contracts
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Extract of sample "In the light of recent examples of banks and companies making heavy losses from using derivatives, evaluate the risks and benefits of derivatives contracts"

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The recent publicised bankruptcies by the Orange County and the British Investment house of Barings purportedly relates to losses from speculative positions in different derivative securities that caused a flurry of discussion, which questioned the derivative investment.
There have been several investor lawsuits on losses from derivatives. For instance, in MG trading subsidiary, in United States, in 1993, there were large derivatives positions in futures and swaps in energy. Instead of the prices rising, they sharply fell in late 1993. The company incurred unrealized losses with the derivatives having margin excesses of $900 million. The press reports indicated that the predicament was as a result of the massive speculation in the energy futures and off-exchange. However, not all the press reports hold on to this; others believe that derivatives in MGRM activities were as a result of complex oil hedging and marketing strategy. Negotiation for most of forward delivery contracts happened in summer of 1993, when prices for the energy were falling. The end-users took advantage of locking-in the low energy prices for the future, and the company benefited through developing profitable customer relationship (Carr & Dilip 2001, p. 33-59).
The large financial losses from the money market funds increased the public concern on derivative investment. There are hot discussions about regulation of the derivative investment. Most of the negative publicity on derivatives reflected by the popular press is partial contrast to the theoretical arguments on benefits of derivatives. This questions the recent concerns on the risks from derivatives since derivatives have a high likelihood of reducing risks for the financial institutions (Carr & Dilip 2001, p. 33-59).
A derivative entails the transaction whose value is derived from the value of the underlying assets. A derivative contract refers to a financial contract ...Download file to see next pagesRead More
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