Using the derivatives market to hedge speculative financial risks -

Hedging is todays key risk management technique for financial professionals in a wide variety of roles and markets. While markets each have a unique set of characteristics, most share a fundamental structure that allows risks to be managed using a common set of mechanisms and tools. Derivatives for example are important risk management tools that have made it possible for financial and non-financial institutions to buy and sell exposures, thereby diversifying their risk portfolio and reducing earnings volatility. Given the benefits of using derivatives, the market in derivative products has undergone explosive growth over the last 15 years. Today, derivatives are being used to manage speculative risks such as interest rate, currency, commodity, equity and credit exposures.

Q. Explain the types of derivatives available to trade in the financial markets and how they are used to hedge speculative risks. Analyze the risks that may arise from the use of these financial instruments.

a) Start with an introduction stating the purpose of your report and highlight the main aspects that will be discussed within the body.

b) Explain the types of derivatives traded in the financial markets. They should include futures, options, swaps and forwards.

c) Discuss the purpose of these derivatives and how they are used to manage speculative risks associated with commodities, currency and foreign exchange, interest rates, credit and credit default exposures, equities (stocks) and bonds.

d) Analyze the risks associated with the use of derivatives for companies, banks and financial institutions.

e) End with a conclusion summarizing the main points discussed.