So now let’s talk about the third category of financial products.
Supply and demand risk.
As shown in previous sections, the trade-offs of capital and foreign currencies closed transactions by agreeing on the price. These financial prizes are share prices, interest rates, and foreign exchange rates. These prices change fast and unpredictably, exposing the participants to financial risk that can be a source of substantial losses, professional financial market participants, close high-volume transactions they need to manage those financial risks. The financial participants are banks, large corporations, governments, and other financial institutions like investment funds, hedge funds, pension funds, and insurance companies, financial risk management is driven by two emotions fear and greed.
Fear drives the risk of selling, which is also known as hedging, greed, and what the Fed’s taking or buying risk. Buying of risk is known as speculation. All speculation is driven by greed in search of higher yields on investments, the ultimate risk of speculation is that it can end in loss or default. Financial risk managers make assessments of risk exposures to manage risk exposures. There’s a specific product type called derivatives examples. Derivatives are futures of interest rates and currency swaps, credit default swaps, and options. Futures in force are used to buy or sell financial products into the future at a specific price.
Agreed to close the transaction swaps enables financial market participants to change the interest specifications of loans and deposits. Interest rate swaps exchange fixed for floating interest rates. Currency swaps exchange interest for two different currencies. To manage default risk on the counterparty. There is a relatively new derivative, the credit default swap. Most credit default swaps are used to buy or offer protection for the default of a counterparty. Options make it possible to design a specific risk profile, such as a floor on the commodity price decrease or a cap on the interest rate rise. Financial risk managers can use options to choose the risk level and have created a new universe of risk management. In other words, before options were created, financial risk management was black-and-white television. With options, it’s full color, this graph depicts the history of trade, a derivative known as your volumes, and proves that the practice of risk management by utilization of derivatives has skyrocketed.
The outstanding volume of derivatives has increased from one hundred thousand dollars billion in 1998 to almost seven hundred thousand billion dollars in 2008. This is approximately seven times the annual world economic output of these immense volumes. There is something big happening in the world of finance. It impacts our economies and welfare and most of us don’t realize the extent of what’s going on.
