Current Developments in the Derivatives Markets
Derivatives markets are the financial markets which are primarily for the derivatives. These derivatives are the instruments financially whose value is mainly derived from the something else’s value. This is basically important to reduce the risk for the one party while it was offering a high premium return to another. This are generally will take in the form of the contracts under the parties agree payments in between them which is based on the underlying asset or the other data in a particular point of time. The major types of the derivatives are the futures, the forwards, the options, and the swaps. The derivative market can also be divided into two categories which are for the exchange traded derivatives and the over the counter derivatives. These legal and the nature of these products are different and as well as the way they are traded, but many market participants were both active.
In the past years, the derivatives markets had experienced so much tremendous development growth. All of the types of the entities in all the industries or even in the public organizations are all using the financial services industry. In between of the June of 1998 and the December of 1999, notional for the payment in the global OTC had rose of about trillion. Between April 1995 and April 1998, the average daily turnover in the Global OTC derivatives markets rose for about the 50 percent, while the turnover on the derivatives exchanges had rose for about 16 percent to .4 trillion. In the mid of 1999, even at the euro introduction and the effects of the autumn, it was picked up in the 3rd quarter of the year.
In the global OTC derivatives markets the derivative markets, the decreased in the market depth, and the diminished liquidity, and increased the volatility of spreads
has reflected, three factors: the reduction of the market making activity, reducing the proprietary trading; and the greater attention to the risk management. (All the given data were attached at the end of this paper).
The developments in the derivatives markets of the other countries is the impact of the OTC and the exchange traded derivatives markets also. This is because of the implications of the much advance technology system, including all the IT and the outsourcing services. All of this developments has the implications which has to be work in to. One of the major developments is the clearing settlement which is efficient operation of the derivatives and securities markets. One example for this one is the London Clearing Act which was the central counterparty to the trades executed by its 116 members and also considered as the leading central counterparty in the European time zone. This also have objectives which secure the most efficient clearing services in to its members, protecting the integrity of the underlying markets, both in the exchange and the over-the-counter.
The second one of this developments is the regulation and the investors protection which was use to prevent the destabilization of the financial system; it also enable the investors to use exchanges and markets with are confident enough; it establish appropriate levels of customers protection; and to ensure that licensed firm are competent, are honest, and solvent. The alternative trading systems which designs to widen the market trading in the derivatives and that aims the provision of efficient mechanism for the trading. The outsourcing which was there to reduce the operating cost, to focus the operation on core activities and to improve the quality of the e-commerce process. And finally is the market access for the derivatives wherein there is an agreement in the Doha and the WTO that provides opportunities to address the numerous types of obstacles that can affect the international trade in service, which include all the barriers that exist in the financial services sector.
The Financial Risk Management
Financial Risk Management is primarily deals with the risk that can arise directly or indirectly as a result of the financial markets. Analysis of the previous significant losses which suggest that losses often occur as a solution to the speculative trading, to the unauthorized trading and to the not hedging as well as overhedging. Based on the theories that had explained, the financial risk management is requiring a considerable which concerns on the objectives of the management. Because of the complicated agency the relation of the firm, the management objectives can include maximizing the wealth of numerous stakeholders such as the shareholders, the debtholders and the management as well. This can possibly affect the firm whether directly or indirectly.
In the study of the foreign exchange risk management practices and the products which used by the Australian firm, it has been determined that the management practice variables were the usage of the physical and the synthetic risk management products, the degree of the centralization, the usage of short as well as the long term funding techniques and the use of the technology to measure and manage foreign exchange risk.
said that “financial risk management is oriented toward two exposures: interest rate and the currency”. He also added that “ the currency exposures come from the day-to-day operations. As a general rule, we deal with roughly 20 currencies. Most of our exposure is in three, the euro, the Canadian dollars and the British pounds, which accounts for the 90% or more of their exposure”. This was done to hedge his division as part of the management process.
Risk Management and its impact in the Firm
Basically, risk is in nature of the human affairs. Some of the risks are allowing the individual to go the larger group. Others are open for the diversification as engaging in the mutual funds. Since derivatives have become important for the past decades, then financial risk associated with the price volatility in the commodity market.
Management risk plays an important role in the business, taking the petroleum, natural gas, and the electricity industries as examples of the business which are fragile to this kind of market risk. In this arena, the energy companies can forecast of the success of the price venture, its failures, and its performance. Then, diversification of the long term contract, in the inventory maintenance, and the insurance are seems to be the most effective tools for the managing those risk. Energy risk has the economic consequences of the general interest because it has decisively affected the investment in the energy projects.
As soon as the manager decided or the firm’s owners are decided to opposed the risk, there always an action to reduce it. The diversification of the business can be an effective way to reduce the dependence on the performance of the particular industry or the project. Besides diversification is much expensive and it has often fails due to the complexity of managing the diverse businesses. Therefore, the success of the most of the projects is strongly tied up to the state of the general economy and the diversification is not a viable response to the risk. The use of the long term fixed contracts is another way of the managing of the risk which was created by the fluctuation of the price. Insurance contracts can also be the alternative way to manage the risk. By this time, the owner of the plant can purchased the insurance contract that can provide the compensation for lost revenue in the stage of the unplanned outage.
Forward contracts are varied as the parties that are using them whereas they tend to deal with the same aspects of the forward sales. These forward sales are designed to be flexible to match the commercial merchandising needs on the parties that are entering into them. This method will result to the default and the risk to be substantial. Future contracts will answers to the problems of the forward contracts. This future contracts will obligates each of the parties to parties to buy or to sell a specific amount of the commodity at a specific price. The future contracts are not that useful for all of those who want to manage the price risk. The future contracts are available for the only few commodities in the few delivery locations. There is a strong and healthy business that had conducted outside the exchanges in the over-the counter market in selling contracts to supplement the futures contracts and the better meet the needs of the individual companies. Options is also one of the .method in taking the risk, this is use by the managers and the firm owners to put floors and the ceiling on the prices but this method tend to be much expensive. Swaps allow the users to manage the price exposure risk without taking possessions on the commodity. The price risk vary on the effect of the investment risk, wherein the investors tends to have difficulty on the current prices that is indicated in the long term values or the transient events.
Risk managers in the field of the petroleum and natural gas usually use derivatives in order to achieve certainty about the prices they use to pay and they had received. According to the study, the prices should respond more quickly to the new information on the fundamentals of the product which was reflected in the price.
In general, the use of the derivatives has either reduced or even had no effect on the volatility of the commodity prices. The use of the derivatives can also be risky and can be dangerous to the business that can lead to bankruptcy.
Table 1 I t
The exchange Traded Derivative Financial Instruments: National Principal Amounts Outstanding from 1986-first quarter of 2000
In billions of US dollars
Table 2
Annual Turnover in Derivatives Financial Instruments Traded on Organize Exchange Worldwide
In millions of contract Traders
Table 3
Global Over-the Counter Derivatives Markets: Notional Amounts and Gross Market Values of Outstanding Contract, 1998-99
In billions of U.S. dollars
Table 4
Global Over-the –counter Derivatives Markets: Notional Amounts and Gross Market Values of Outstanding Contracts by Counterparty, remaining maturity and Currency Composition 1998-99
In billions of U.S. dollars
Credit:ivythesis.typepad.com
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