Business Funding

Some people believe that derivative is same as everything which is wrong with the capital markets, rampant profiteering and trading for the sake of trading. These are some of the charges that are put against financial derivatives, but this is really a very unfair reflection.

Derivative contracts originated for satisfying the needs of common people. The IMM or International Monetary Market offered the first foreign exchange futures contract of the world in the year 1974. The origin of these derivative contracts arose from the requirement of stabilizing fluctuations in foreign exchange after breaking down of Bretton Woods after the Second World War.

As all new abstraction layers were built upon the previous layers, the derivatives trading became more popular for encompassing more aspects of financial markets. Over the past few decades, the trends have continued with increased complexity. The global market of today trades dollars every day in trillions. The correlations and interactions between the markets were considered as separate but today, they are closely connected to each other, with the shocks in prices rippling from this market to that. Undoubtedly, the development of the computer systems has largely contributed to the growth of the markets.

Ironically, the computer systems are unable to undertake risk management and therefore, they cannot keep pace with markets which are still holding back development. The landscape of IT systems within most of the investment banks has now become highly complex, as there are several different systems interrelating in ways which are difficult for normal people to understand. A huge number of consultants and specialists maintain delicate systems, who believe that you should not fix anything that is not broken.

Trading firms are prone to undergo substantial losses because of the failures of the potential system. Operational risks within the IT systems have the ability to bring around a collapse to an entire firm. Therefore, this is the right time for the banks to face this overwhelming problem and find a solution for it at the root level. Rather than adding patches onto the existing systems, you need to make radical investment for cleaning up and bring about a well architecture and structured system.

People who earn money with financial derivatives usually generate income and hedge against the potential losses. When a large financial institution invests a huge amount of money into investment instruments with 100% potential of losses and without any underlying assets, then mass failure is clearly foreseen. This is why, financial derivatives should be considered by the educated and knowledgeable investors and speculators.