Derivatives are an integral part of modern financial markets. Simply stated, a derivative instrument is a contract between two entities that specifies the values, dates, notional amounts and other conditions under which the transaction between them is to take place (usually at a future date). Derivates play an important role in streamlining economic activity, as well as to facilitate liquidity in the markets. Credit derivatives are an especially sought after instrument due to the legal exemptions afforded it. On the flip side, the inherent complexity and speculative element in derivatives make them a high-risk option. In the context of financial market booms and busts, derivatives are often criticized for artificially (yet inevitably) creating these cycles. For this reason, it is not unreasonable to claim that ‘derivatives are toxic instruments of financial mass destruction’, although they have their utility when employed prudently.
The role played by . . . Read More