The Advantages and Disadvantages of Exchange Traded Derivatives.

2110 Words9 Pages
“The International Swaps & Derivatives Assn. recently estimated the worldwide market at $ 105 trillion. The Office of the Comptroller of the Currency (OCC) says U.S. commercial banks held $ 56 trillion of derivatives at the end of 2002”, and by comparison the GDP of the US was estimated to 10.4 trillion the same year. The world’s largest financial market today is therefore without doubt the derivative market. Derivatives have come into existence because nearly every business has its risks. Derivatives are used to protect against key-business risks which are beyond our control, such as movements in the markets of commodities and foreign exchange . Those who use derivatives as a way of managing risk are called hedgers. Martin Taylor,…show more content…
The derivatives market makes it possible to make money, whether the market is in bear or in bull. If an investor believes the market will rise, he can either buy call options, write a put option or buy a futures contract and vice versa if the market is believed to fall. The futures market gives investors and traders the ability to take a short position in the underlying, which is selling something you do not have. It is important to be aware that huge losses may occur if the market moves in the opposite direction. Derivatives may as well offer tax advantages over otherwise comparable financial strategies; it may reduce transaction costs and enhance liquidity. Derivatives create a more efficient market. In the stock-market for example, when not moving very much, investors are sometimes better off selling their shares and move their funds in to the money market. Derivatives enable them to make a profit regardless of the market is at status quo, rises or falls, and moving their funds is less attractive. By buying or selling exchange-traded derivatives the investor is exposed to less risk than those who trade Over-The-Counter. The risk of default by a counterparty is transferred to the exchange, in return for deposits called margins from buyers and sellers. A lot of the derivatives scandals, such as Orange County and Metallgesellschaft were a result of Over-The-Counter trading. The Exchange offers greater liquidity, but investors are not
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