Derivatives
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Basis is the variation between the spot price of deliverable asset or commodity and the relative price of the futures contract of the same actual that has the shortest duration until maturity, the value of basis determine the value of the contract and therefore a crucial tool to the mangers and traders it determines the profitability of the contract, high basis are highly risky but equally profitable.
Futures contract are settlements or agreements to sell or buy a specific quantity and quality of goods at the current price in future which should be met on the delivery or settlement date. For example, if a trader thinks oil prices will increase from $50 to around $60 he can enter into a futures contract to sell a specific amount of oil at the current price, which should be done on a specified future date (settlement date) regardless of the future prices, low or high. If the futures prices are $57, the future basis for the contract is $7.
Forward contracts, unlike futures forward contract are private as they are not-standardized or traded on exchange; their terms vary from contract to contract, forward points basis is the points subtracted or added from the spot rate to determine the forward rate. If euro to dollar exchange rate is currently at 1.340$/€, on an interest based using interest rate forward yield curve to determine the forward outright rate for next six months, if the future date rate is 1.353$/€ the basis for this contract will be +13.
Ethical issues in using derivatives instruments.
Most business want fixed interest rates for their loans, some investors especially through swaps bridge between the bank offering variable interest then offer the first business the loan at fixed rate. In an event that the intermediary goes bankrupt the first business is forced to pay the variable rates and if they are too high for the business it is also forced to close.
Derivatives are risky as they are primarily meant to transfer risk from one party to another depending on the ability of an investor to take risks. Young investors are attracted by the high possible returns, if the contrary happens the traders are set in a chain of actions that have a negative effects on global and domestic economics. Although derivatives are widely used means for leverage they are high causes of recessions and economic depressions hence considered as weapons for economic destruction if not used wisely.
With the rise of derivatives in the 1900s there came a lot of bucket shops, this are fraudsters who operated small shops luring innocent traders into specific securities and options contracts after which they would relocate to other locations before the contracts matures. This instruments can be used maliciously to steal from innocent traders.
The swaps contracts were introduced in the late 1980s a few years after introduction of non-physical commodities futures, long after the commodities futures contracts had been banned in US. These instruments with time have become more complex and few people can comprehend them, they are entrusted on bank managers and traders (mathematicians) on behalf of shareholders and other investors. Without taking into considerations the traders and managers engage in very risky. Many managers have been found selling defective products since the customers do not understand.
Global market integrity and trust has been affected greatly by the introduction of the derivative in the finance markets. In a survey done by CFA institute shows that many traders wish more regulations and law enforcements needed to be put in place to uphold needed market integrity.
Over the years the credit default swaps (CDSs) have been dominated by naked bondholders as opposed to corporates for hedging their bonds. Some companies which depend on the CDSs run shot of fund due domination by uncovered CDSs. Due to this reason most credit defaults do not get regulated because they do not go through the central clearing house, so no one get the right value of some CDS contract.
References
Hoje J, C.L –(2010)
Unethical Misuse of Derivatives and Market Volatility Around the Global Financial Crisis. Journal of Academic and Business Ethics pp8-9
O.C, F, J-(2011) Banking Industry Meltdown: The Ethical and Financial Risks of Derivatives. Daniels Fund Ethics Initiative, University of Mexico.4-9
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