Following the volatility in the bond and stock market in the 1970s and increasingly in the...

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Following the volatility in the bond and stock market in the 1970s and increasingly in the 1980s and 1990s, the financial markets became very risky as interest rate swings widened. As a result of this, new financial instruments came into existence that helped the managers assess their risks better. These instruments were in the form of financial derivatives that have been very effective in reducing the risk that many financial institutions face. They are involved in hedging – that is engaging in a financial transaction that reduces or eliminates risk. "Hedging risk involves engaging in a financial transaction that offsets a long position by taking an additional short position or offsets a short position by taking an additional long position. Required: a) b) Analyze the pros and cons of financial derivatives while at the same time glancing into past derivative-related crises to explore the dangers of financial derivatives. Examine the credit default swaps and their role in the recent credit crisis. (25 Marks) (25 Marks) Following the volatility in the bond and stock market in the 1970s and increasingly in the 1980s and 1990s, the financial markets became very risky as interest rate swings widened. As a result of this, new financial instruments came into existence that helped the managers assess their risks better. These instruments were in the form of financial derivatives that have been very effective in reducing the risk that many financial institutions face. They are involved in hedging – that is engaging in a financial transaction that reduces or eliminates risk. "Hedging risk involves engaging in a financial transaction that offsets a long position by taking an additional short position or offsets a short position by taking an additional long position. Required: a) b) Analyze the pros and cons of financial derivatives while at the same time glancing into past derivative-related crises to explore the dangers of financial derivatives. Examine the credit default swaps and their role in the recent credit crisis. (25 Marks) (25 Marks)

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Answer a Pros and Cons of Financial Derivatives and Dangers Pros Risk Management Derivatives like forwards futures and options allow institutions to manage various risks including price risk fluctuati... View the full answer