Are financial derivatives a barrier to investment banks?
In recent decades, the development of financial derivatives is one of the most important and striking features among international financial markets (Lei, D.2009). Meanwhile, international investment banks gradually increase their utilization of financial derivatives in investment management strategy. Business related to derivatives has also become the core competitive ability to investment banks. With the development of the international financial markets, the range for investment banks using financial derivatives has almost cover all current financial tools. However, with the outbreak of the financial crisis, many investment banks suffered fatal blow, financial derivatives then became the blame objective by some authorities and the public. For investment Banks, finding out the risk exposure of financial derivatives and implement strict supervision, appears to be an efficient way to achieve their financial goals. This essay will first introduces the relevant theoretical knowledge of financial derivatives and its current develope situation in investment banks, and then based on the analysis of the operations by looking at some examples, reveal the potential high risk of financial derivatives during the process. At last, whether financial derivatives should be banned as a barrier to the investment banks' development or could be issued and managed will be discussed.
Financial derivatives and their markets
2.1 The concept of financial derivatives
Financial derivatives, refers to single and combinations of financial contracts which derived from the original financial tools. A definition is presented by Gregory (2010), who asserts that derivative contracts represent agreements, either to make payments or to buy or sell an underlying contract at a future time. Therefore, an outstanding characteristic of financial derivatives refers to the explicit temporal dimension of a contract. With the rapid development of derivative markets, the types of derivative products has becoming more and more. According to different forms, it could be classified as forward, futures, options and swap. At the same time, financial derivatives vary based on underlying assets, including stock equity derivatives, currency derivatives, interest rates derivatives and credit derivatives.
2.2 the function of financial derivatives
As a kind of high efficiency measure to hedge risks, the generation of financial derivatives provides a new choice for investors to reduce and prevent losses due to exchange rate, interest rates and other change factors may lead to adverse effects. That is to say, financial derivatives reduce their expected income fluctuation degree.
From this point of view, there are two basic economic functions of financial derivatives: the first one is the transfer of risk, another is price discovery. And its affects mainly display in the following: financial derivatives can promote the prosperity of the financial market's stability and development, and also helps to reduce the information asymmetry in the process of transfer. Meanwhile, it helps to form a more reasonable price of resources allocation and effectively promote the capital flow. In addition, financial derivatives also play an important role in macroeconomic management and regulation.
2.3 the general operation process of financial derivatives in investment banks The general process could be summarized as follows. Investment banks make advantage of their exquisite professional skills, usually the financial engineering technology, to call in funds with different credit ratings and different rate of return, which will become new products with processes of segmentation, packaging and combination. Then after evaluated by credit rating agencies and guaranteed by insurance companies, those products can be largely poured into the financial market...
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