Berkshire Hathaway Derivatives

The 2008 stock market crash is largely regarded by economists as one of the most devastating economic collapses in known history, almost being on par with the Great Depression. The 2008 market crash has been termed “the Great Recession” by economists, portraying just how bad it really was. Income plummeted, home value took a nosedive, and the DOW dropped over 700 points in a day (the most extreme drop in history). An extreme range of events transpired over an incredibly short amount of time, which was what caused the panic during and after 2008 and credited the crisis with its now notorious history and effects. These events snowballed from events far before the actual crisis, but really started with the housing crisis in 2007.

In 2008, the whole world encountered the biggest crisis on the economy generally in the finance sector. One of the essential driving factors of this was the deregulation in the finance industry. It permitted financial organizations to be engaged with offsetting the risk in fund exchange with the derivative. As a result, the financial institutions (like banks) claimed for more mortgages that would support derivatives trade that was profitable (Scott, 2010).

In the history of investing, Buffett stands alone. He found his interest in investing when he was very young. In fact he bought his first shares at the age of 11 with the help to his father. Buffett was interested in making money since he was child and he made money by selling chewing gum, soda bottles, newspaper and magazine, golf ball and stamps door to door. After graduation, he worked with his father Buffet-Falk &Co, then for Benjamin Graham, then opened his own firm Buffet and Partnerships and finally at the age of 35, he became the chairman and CEO of Berkshire Hathaway Inc.

The financial crisis of 2008, which caused the most damage in world economies between the years 2007 and 2009, has a long list of potential culprits that helped to initiate the crisis. The global economy has become so entangled that it is isolate a specific "first cause" or be able to point the blame at any one group in isolation. However, economists now have a whole range of specific causes in which they attribute to the crisis, yet this is still somewhat in dispute. In reality there are most likely a multitude of different factors that all contribute some role in the formation of the crisis. Some common culprits seem to be the repeal of the Glass Steagall Act, the creation of derivative trading, as well as the whole subprime area of lending. However, each of these factors did not exert its force in a vacuum. Markets today are extremely dynamic in nature and all of these factors played a domino role in destabilizing the others.

Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices or other underlying notional amounts. Derivatives are carried at fair value on the consolidated balance sheets in derivative assets or derivative liabilities. We elect to present any derivatives subject to master netting provisions as a gross asset or liability and gross of collateral. Disclosures regarding balance sheet presentation of derivatives subject to master netting agreements are discussed in Note 3 – Derivative Instruments. We may designate derivatives as cash flow or fair value hedges.

As of 2014, more than 11,000 hedge funds are managing more than $2.6 Trillion in assets (De Pol, 2015). The statement itself speaks how important these hedge funds are in the global financial market. They provide investors with opportunities to achieve gains and manage risks. Hedge funds provide liquidity and make financial markets more efficient. These funds can be operated with extreme flexibility and play an important role in financial innovation and reallocation of financial risk (Rubin et al, 1999). Although it sounds good, hedge funds took a hit during the 2008 crisis. Along with the credit crisis came Madoff fraud, the biggest investment scam in 2008. Investors started looking at these funds as high risk, highly leveraged investment vehicles that lacked transparency. Since mid-2009 hedge funds have picked up and strategies are being improved for better risk management, transparency and gaining confidence of investors.

A hedge fund is a regulated investment fund that is typically open to a limited range of investors who pay a performance fee to the fund’s investment manager. Every hedge fund has its own investment philosophy that determines the type of investments made and strategies employed. In general, the hedge fund community undertakes a much wider range of investment and trading activities than traditional long-only investment funds. Hedge funds invest in a broader range of assets, including long and short positions in equity, bonds, commodities, and derivatives. Hedging out unwanted risk has been a common activity in the financial markets for centuries. In the 1800s, for example, commodity producers and merchants started using forward contracts to protect themselves against futures changes in commodity prices—these contracts hedged out the risk of adverse market fluctuations beyond their control. Such forward contracts are still traded to this day in the futures market. Alfred Jones is credited with the creation of the term “Hedge Fund” in 1949. He created A.W. Jones, a partnership with four friends, and through this vehicle he invested $100,000 in stocks, using both long and short positions. During the first year, the fund returned 17.3%. The idea has caught fire since.

Derivative use was concerning to investors mainly because they did not fully understand the complex swaps, and saw them as risky. Banks had not typically invested so heavily in swaps, so investors felt that Banc

Harry Markowitz is one of the founders of the theory of finance, the fastest growing

“A complex network of financial derivative products held globally, started to un-ravel, US mortgage crisis was only the tip of the iceberg”.

Economic derivatives could be so unsafe that they could even a great cause of financial disasters. This is because many investors turn to financial derivatives market to direct them into future funding, rather than of observing at the genuine market. This can lead to market distortions and hence can be extended to other parties of the market connected in the market and thus financial position of a country can be obstructed badly. Derivative instruments were created after 1970s as a way to manage risk and create insurance downside. They were created in response to the frequent oil market shocks, inflation and drops in the stock markets. Hence the initial intend was to defend against the risk and protect against the downside. However, the derivatives became speculative tools often used to take more risk in order to maximize profits and returns. Derivatives do ensure against the risk when used properly, but when the packaged instruments became too complicated that neither the borrowers nor the rating agencies understood them or their risk and hence the initial premise just failed. Not only did investors, like pension fund, got stuck holding securities that in reality turned out to be equally as risky as holding the underlying loans, bank got stuck as well. Banks held many of these instruments on their books as a source of fixed income requirements and hence using these derivatives instruments as a collateral. However, later it was found out that they had less

“Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway”……WARREN BUFFETT

12 years ago, Warren Buffett warned that derivatives were “financial weapons of mass destruction” (Lenzner). 6 years after he made this statement, derivative traders helped induce the biggest financial crisis in America since the Great Depression. Derivatives are highly complex financial instruments that have fundamentally changed the way we perceive finance. Trading these derivatives has caused a financial revolution that has generated both a huge amount of potential, and an an equally huge amount of risk. Derivatives, in a nutshell, are highly complex financial instruments whose values are dependent on, calculated

Virtually all financial decisions carry some implication of risk, because of the uncertainty of the future. However, the concept of market transparency suggests that regulators and ordinary consumers do have the ability to try to predict what will occur, based upon the knowledge of a company's holdings. However, the use of derivatives means that it is very difficult for ordinary consumers to accurately value the level of risk they are entering into, because there is little transparency about the real level of risk or the value of the financial instrument in question. Despite the calls for transparency in the new global economy and increased public scrutiny of business activities, the level of complexity of the derivative market makes it difficult for ordinary shareholders or even government agencies to follow and monitor it (Ferrell, Fraedrich & Ferrell 2008: 280). Derivates "are contractual arrangements between two parties at least one of which is likely to be a giant financial institution that transfer risk. They typically have

Derivatives are able to eliminate unexpected risks arising from the price volatility of an asset, however they have often been implicated in the most controversial organisational meltdowns and financial crises. The evolution underlying assets in derivative products have pushed the development of legislation to support these changes. The Chicago Board of Trade was the first centralised derivative trading market, since then the United States regulation on derivatives have served as a basis from other countries when regulating their markets. The research wants to evaluate the impact that the changes in the underlying instrument had on regulation. A historiography as a research methodology is proposed, were a historiographical