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The Impact Of Financial Derivatives In International Finance Contents ...

The Impact of Financial Derivatives in International Finance

Contents

Abstract 2

Chapter 1 Introduction 2

Chapter 2 Derivatives 4

Chapter 3 Impact of Credit Derivatives and Other Derivatives10

Chapter 4 Conclusion 16

Bibliography 18

Abstract
The impact of derivatives on financial markets represents a perspective that has its positive as well as negative points. The question is, are they more good than bad, or more bad than good? As financial instruments crafted to creatively solve problems, and or generate new streams of profits, derivatives occupy both sides of the fence. This examination shall thus seek to look into the positive as well as negative aspects of these financial instruments, derivatives, and weigh the overall effect of their benefits against their drawbacks.

Chapter 1 Introduction
A derivative represents a financial instrument whereby its worth is derived from the underlying value of an asset (Solomon, 1999, p. 111). Participants in the market thus do not trade, and or exchange the asset, rather they enter into an agreement whereby they exchange money, or assets, or another form of value at a date in the future, based upon the underlying asset (Solomon, 1999, p. 111). It is a transaction that entails a swap, forward, future, option, or a combination of these contracts that is ‘derived' from an underlying asset such as a security or commodity, or from a rate such as an interest rate or exchange rate, or from an index such as a stock exchange (Solomon, 1999, p. 111).
Derivatives permit the hedging of risk and the swapping of financial features, such as the exchange of an asset or liability denominated in one currency for one denominated in another currency, or the exchange of a variable interest asset or liability for one with a fixed interest rate (Solomon, 1999, p. 111). An option gives an investor the right but not the obligation to buy or sell an asset at a given price, which is called the ‘strike' price. Assets in this instance can represent anything of intrinsic value, such as precious metals, stock or sometimes be as variable as an interest rate. Cocheo (1993) explains derivatives as contracts obligating the parties to make payments to each other, or one to the other, under specified circumstances. And that they can be more broadly defined to include such "derived" securities as collateralized mortgage obligations and other structured financings such as asset-backed securities (Cocheo, 1993).
Derivatives have a long history, thus their origin is worth mentioning. Sometimes referred to as ‘front contracts', or contracts for deferred delivery derivatives were used for transactions on organized markets at least as early as those of medieval and Renaissance Europe (Cornford, 1996, p. 1).