Why do derivatives figure so highly in bank losses?
It has been reported that French bank Caisse d'Epargne has taken a £460 million hit on what it describes as a 'trading incident'. While the French authorities are looking into the matter to see exactly what happened, it seems more and more we are hearing about derivative losses around the world. Surely if derivatives are so risky there should be more regulatory safeguards?
The truth of the matter is that in the right hands derivatives play a vital role in any investment market and can act as an insurance policy when used in conjunction with traditional investments. The problem over the last few years has been the number of companies and investors using them to obtain highly leveraged positions to a market without having to stump up all of the funds in one go.
If the markets move the in right direction these often highly speculative trades can produce massive returns but if the markets move against a trader they can spell disaster. The problem at the moment is the fact that we are in such volatile markets that an investment can flip over in a matter of seconds and if the market gets wind that a trader needs to unwind a loss making position this can often depress prices even more.
Derivatives are a useful and essential tool for investment markets but they need to be respected!
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