Financial derivative instruments: Impact on global financial flows
Table of Contents
Introduction to Derivatives 3
Advantages of derivatives 4
Disadvantages of derivatives 4
I. Abuse of derivatives 5
II. Misuse of derivatives 6
Role of derivatives in a developing economy 7
Direct correlation between capital flow and derivative transactions 9
Time series analysis 10
Time Series Analysis 1: 11
Flaw in analysis: 12
Time Series Analysis 2: 13
Conclusion from analysis 13
Change in accounting system to include Derivative transactions in BOP account: 14
Implication for India’s BOP account 14
Derivative transactions have increased 13 times from 2004 Q1 to 31st July, 2009-08-01 16
Huge transactions in the unregulated OTC market are difficult to account 17
How Derivative trading can affect a country’s economic stability? 17
Role of Derivatives in current economic crisis 18
Proposed changes in policy to neutralize the disadvantages 20
Bibliography 21
Appendix 24
Introduction to Derivatives
Derivatives are the category of financial instruments which include futures, forwards, swaps, options and other structured securities. They “derive” their value from an underlying item such as a commodity, security, rate, index or event. Derivatives perform the economically useful task of risk shifting and thus are an active instrument in hedging risk. Moreover, they also induce price discovery in futures market.
Capital markets which include securities markets (issuing and trading bonds and equity shares and involves FDI and FII related activities), banking industry (issuing loans and providing payment and settlement services), insurance and pension funds (providing future income and collateral for lending), is incomplete without the presence of derivative markets which essentially performs the task of risk management and price discovery.
Industrial revolution of East Asian economies and Latin American countries in late 1990s strained their...