A Brief Study of Derivatives and Risks

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Hedging is a significant measure of financial risk management. Since the 1970s, the increasing number of powerful companies started to control the risk of the exchange rate, the interest rate and commodity by using financial derivatives. ISDA (2013) based on the Global 500 Annual Report 2012 survey found that 88 percent of companies use foreign exchange derivatives. Modigliani & Miller (1958) believed that if the financial markets were under perfect conditions, for instance, there was no agency costs, asymmetric information, taxes and transaction costs, hedging would not increase the company 's value because investors can hedge by themselves. However, a large number of practical studies have shown that hedging is beneficial

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Analyze the derivatives market and determine the use of derivatives to efficiently manage investment risks in an investment portfolio.

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Even though this change will cause an increase in the volatility of profit and loss, it is likely to reduce risky investments in derivatives and increase accountability among managers and accountants. Treating some derivatives as off-balance sheet derivatives has in the past caused some managers and accountants not to display some derivative trading activities, especially if they are faced with high speculative risks. Highly risky investments cause a business to collapse. One example of a failed company due to risky investments is Barings Bank which collapsed due to highly risky derivative trading. The company’s manager of the Singapore branch engaged in highly risky derivative trading and kept them off balance sheet, and manipulating the accounts to show positive profits (Reserve Bank of Australia, 1995). However, the reality was that the company was making losses. The company

Among the most fundamental risks, associated with exchange-traded derivatives, is variable degree of risk. According to Ernst, Koziol, & Schweizer (2011), the transactions in

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With the globalization of trade and free movement of financial assets, risk management through derivatives became a necessity in India. In the early nineties in India the economic liberalization provided the economic rationale for the introduction of forex derivatives. Many business houses actively approached foreign markets not only with their products but also as a source of capital and direct investment opportunities. In 1993 there was limited convertibility on the trade account so the environment became more conducive for the introduction of these hedge products. The development in the forex derivative market was carried parallel along with the steps taken to reform the Indian financial market. In 1992 FII’s were allowed to invest in Indian equity and debt markets and in the following year foreign brokerage firms were allowed to operate in India. NRIs (non-resident Indians) and OCBs (Overseas Corporate Bodies) were allowed to hold together around 24% of the paid-up capital of the Indian companies and it was further raised to 40% in 1998. The Indian companies were encouraged to issue ADRs/GDRs in 1992 to raise foreign equity. An Indian entity was allowed to make investments in overseas joint ventures and wholly owned subsidiaries to a limit of US$ 100 million during one financial year. Investments in Nepal and Bhutan were allowed to a limit of INR 3.5 billion in one financial year. Companies located in Special Economic Zones can invest out of their balances