About | HeinOnline Law Journal Library | HeinOnline Law Journal Library | HeinOnline
LOG IN
LOG IN

1 Stan. J.L. Bus. & Fin. 195 (1994-1995)
An Overview of Derivatives as Risk Management Tools

handle is hein.journals/stabf1 and id is 201 raw text is: An Overview of Derivatives As Risk Management Tools Bernard J. Karol' Derivative products have been the subject of a great deal of atten- tion and criticism in the media recently. Unfortunately, much of the mainstream publicity, which has focused primarily on the losses suffered by some derivatives users, fails to give a balanced view of derivatives. The purpose of this article is to provide an overview of derivatives and their applications in markets today, with a fo- cus on how they can be used to manage risk. The article provides a brief history of derivatives in modern markets and summarizes some of the risks associated with using these powerful financial tools. A rash of recent publicity suggests that financial derivatives are new and unknown. In fact, derivatives have a long history. The basic building blocks of derivatives-options and forwards-have been in use for centuries.' However, as finance has grown more sophisticated, the applica- tions of these building blocks have become more creative and complex. The use of derivatives has grown exponentially in the last fifteen years and has transformed global financial markets. This article provides a brief description of derivative products and their role as powerful risk management tools. I. The Building Blocks of Derivatives The somewhat imprecise term derivatives is a recent development and is generally used to describe contracts or securities whose values depend an (or derive from) the prices of underlying assets. Derivative products consist of either options, forward contracts, or a combination thereof. Therefore, options and for- wards may be considered the basic building blocks. An option is a contract in which the holder (the buyer) pays a certain amount (the premium) to the writer (the seller) to obtain the right, but not the obligation, to buy from the writer (in a call) or sell to the writer (in a put) a specific asset at an agreed price at or before a certain time. The holder pays the premium at inception and has no further financial obligation. If an option is exer- cisable only at maturity, it is a European option; if it also is exercisable prior to maturity, it is an American option. If it is exercisable only at certain times, it is a Partner, Carter, Ledyard & Milburn, New York J.D., Notre Dame Law School. As far back as 1570, London's Royal Exchange served as a meeting place for traders of commodities and manufactured goods, with dealers acting as middlmen to absorb price risk. The first recorded case of organized futures trading involved rice trading in Japan in the 1600s. The Chicago Board of Trade began trading futures contracts in 1851. RICHARD J. TEWELES Er AL, THE COMMODrrY FuTUREs GAME 7-10 (1977). See generally PETER L. BERNSTEI N, CAPmAL IDEAS (1992) (discussing generally the history of capital markets). Bernstein notes that a 1688 treatise on the workings of the Amsterdam stock exchange reveals that options and similar types of in- struments in conuno use today were already dominating trading activities at that time. Id. at 204.

What Is HeinOnline?

HeinOnline is a subscription-based resource containing thousands of academic and legal journals from inception; complete coverage of government documents such as U.S. Statutes at Large, U.S. Code, Federal Register, Code of Federal Regulations, U.S. Reports, and much more. Documents are image-based, fully searchable PDFs with the authority of print combined with the accessibility of a user-friendly and powerful database. For more information, request a quote or trial for your organization below.



Short-term subscription options include 24 hours, 48 hours, or 1 week to HeinOnline.

Purchase Access

Contact us for annual subscription options:

Contact Us

Already a HeinOnline Subscriber?

Log In

profiles profiles most