The financial derivatives aren’t new at all ; they have been there since years. You will find a description of initial known options contract in the Aristotle’s writings. The financial derivatives are vital instruments for assisting the organizations to reach the risk management objectives. Basically, it’s with all instruments that the user needs to understand the function of the instrument and then the safety precautions should be taken to make use of the instrument.
As the builder makes use of the power saw for constructing houses for effectiveness as well as efficiency, the financial derivatives could be a useful instrument for helping the corporations as well as banks to become more effective and efficient in meeting the risk management goals. But, the power saw can also get dangerous when used improperly or blindly.
Therefore, if the users of the power saws are not careful, it will cause serious harm and ruin the entire project. Similarly, if the financial derivatives aren’t used properly, they can cause serious damage leading to losses impelling the organization in a wrong direction damaging the future.
Financial derivatives have to be used properly and will surely help the organization to fulfill the risk management goals so that the funds are handy for making the best investments. Also, the company’s decision to utilize the financial derivatives should have the risk management strategy based on wider corporate targets.
The most basic form of questions regarding the strategies in the risk management needs to be addressed. For example, which kind of risk needs to be hedged and further which ones should remain unhedged ? Which type of trading strategies and derivatives are the most appropriate? How is the performance of these instruments going to be in case of decrease or increase in the rate of interest? What will be the impact of these instruments if there are terrific fluctuations in the exchange rates?
Therefore, if you do not have a defined strategy of risk management, it should be very dangerous to use the financial derivatives. The same can put the firm’s accomplishment in danger and can hamper the long term objectives resulting in unsound and unsafe practices which can result in insolvency of the firm. But, if the same thing is used wisely, the financial derivative can increase the value of the shareholder by providing means to control the risks and cash flow better.
In short, the financial derivatives are just not a latest fad of the risk management. The financial derivatives are going to stay. We are right on the track to the true world financial market that will go on continuing with new innovations for improving the risk management practices. They are surely not a fad but are vital tools for helping the organizations for better management of the risk exposures.
In the end, the financial derivatives need to be considered as a part of any of the company’s strategy of risk management for ensuring that the value enhancing opportunities in investment are achieved.