Topic D: Derivatives (e.g.. options, futures) are often criticized for being too risky and causing massive losses to investors (e.g. Barrings Bank, LTCM). Explain the role of derivatives in financial markets and their desirable and undesirable uses.
             The use of derivatives in the financial market has dramatically increased in recent years. This relevantly recent change in the status of derivatives has led to calls for increased regulation. Fears that using derivatives to hedge against risk carries in itself a new risk which was brought sharply into focus by the collapse of large major financial institutions such as LTCM and Barrings in 1995.
             To explain the role of derivatives in the financial markets, we need to understand what derivatives are, how they can be used to minimize risk and why there is such an increasing pressure to increase regulation on the use of derivatives as a financial tool.
             Derivatives are financial contracts whose value derives from underlying securities prices. For example: Interest rate, foreign exchange rates, market indexes or commodity prices. Exchange-traded derivatives are standardized products traded on the floor of an organized exchange and usually require a good faith deposit, or margin when buying or selling a contract. Over-the-counter (OTC) derivatives such as currency swaps and interest swaps are privately negotiated bilateral agreements transacted off organized exchange.
             Most financial derivatives traded today are the "plain vanilla" variety, the simplest form of a financial instruments. But variants on the basic structures have given way to more sophisticated and complex financial derivatives that are much more difficult to measure manage and understand. The more complex instruments are designed to hedge complex risks in an effort to reduce future uncertainties and manage risks more effectively, however these require a firm understanding of the tradeoff of risks and rewards.
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