Conclusion on Derivatives as a Risk Management instrument

This survey highlights derived functions as one of the most widespread instruments for hazard direction amongst both fiscal and non-financial houses. Their usage continues to increase chiefly as a manner to fudge or to obtain higher grosss. This, like with other instruments increases exposure to hazard. However, the immense losingss suffered by companies, financess and Banks as a effect of abuse have instigated inquiries about its utility and instigated tonss of talk in the media. This spurred an involvement for the writer, in the factors act uponing the mode in which these instrument are used ( the grounds why ) .

The purpose of this survey is to find whether the below hypothesis is valid:

There are a manifold of grounds refering ‘users ‘ and ‘controllers ‘ , instead than the derivative instruments themselves, that lead to unprofitable determinations.

Furthermore, to reply the research inquiries, highlighted once more below:

What are the regulating factors that influence the safe usage of derived functions?

Is the job the derivative instrument itself? Should derivative usage be considered lunacy? Are they so bad and unsafe?

In kernel, the survey has shed more light on derivative instrument usage, the misconceptions and inaccurate myths that surround them. It has shown though a assorted attack of qualitative and a quantitative methodological analysis, that when this instrument is used suitably, it can supply houses with more concern avenues and is a utile tool for a more robust, flexible and efficient hazard direction. It shows that the instrument aids in cut downing or extinguishing the impact of market variables, by increasing the options available for extinguishing or cut downing unwanted hazards. Furthermore, the survey provides decisions on the hypothesis and feedback on the research inquiries.

The hypothesis was tested and the research inquiries were investigated by utilizing assorted tool which included instance surveies of fiscal and non-financial houses and the current fiscal crisis, a study which was analysed statistically and qualitatively ( the open-ended inquiries ) and interviews which were analysed qualitatively. In fact the Hypothesis which is repeated above, was found to be right, after looking at the 3 chief beginnings of this survey ( instance surveies, the study and the interviews ) and comparing it to the literature.

Through these it was revealed that derived functions are non the job that leads houses to do unprofitable determinations and hence influences the safe usage of derived functions, but other factors which will be highlighted and discussed below.

Case surveies

The instance surveies where divided into 3 subdivisions, one for fiscal houses, another to cover the current fiscal crisis and the 3rd to cover non-financial houses. In the three subdivisions the writer analysed the function played by derived functions in the fiascos of Barings Bank, AIB and Societe General ( SG ) ( fiscal houses ) , In the current fiscal crisis and in Metalgesellscaft ( MG ) and Enron ( non-financial houses ) . He so used qualitative methods to find in each instance what the regulating factors that influence safe derived function usage are. Propositions/issues identified following the literature reappraisal ( Yin, 2003 and Stake, 1995 ) and themes/codes identified utilizing the thematic attack for the codification ‘other ‘ ( Braun and Clarke, 2006 ) ( Lofland et al. 2006 ) . Furthermore, lessons learnt and solutions identified were besides noted.

In the fiscal houses section the writer made a comparing to find whether one can claim similarities and that although controls might hold been put in topographic point, the jobs still remain. In fact similarities were noted both in the event occurrences and in the factors identified as act uponing the safe usage of derived functions within these houses. In all three instances the existent job is non of derived functions but is caused by the deficiency of acknowledgment of the factors identified to hold an consequence on derivative safe usage. The fiscal crisis besides revealed a similar decision, in that it is non the OTC ( such as CDSs ) that are to fault but once more the failure to make something about the factors identified as act uponing the safe usage of derived functions. In the last subdivision which refers, to non-financial houses, decisions reached are similar to that reached by the other two subdivisions that the jobs caused by the derivative instruments used are a effect of non recognizing the factors act uponing derivative safe usage and therefore they are non themselves the job, but the manner they are handled.

The Matrix below summarises and shows the similarities in identified factors between all instances and specific factors identifiable to one or a few instances.

Table 5.1 Factors act uponing the safe usage of derived functions ( Case Studies )

Fiscal Firms

Fiscal Crisis

Non-Financial Firms

a

Lack of segregation of responsibilities between forepart and back offices.

Lack of segregation of responsibilities between forepart and back offices.

B

Lack of appropriate internal controls and Inappropriate Standards

Inappropriate controls, criterions and inefficient inducements

Lack of appropriate internal controls and Inappropriate Standards

degree Celsiuss

Lack of appropriate supervising

Lack of appropriate supervising

vitamin D

Lax regulators and policies

Lax regulators and policies

vitamin E

Lack of Knowledge and apprehension of Managers ( users and accountants )

Inappropriate preparation and expertness

Lack of Knowledge and apprehension of Managers ( users and accountants )

degree Fahrenheit

Lack of Communication

Lack of Communication

g

Complexity and perceptual experience of the utility of derived functions

Complexity and Perception on derived functions

Complexity and perceptual experience of the utility of derived functions

H

Greed, hubris and the desire for power

Greed, hubris and the desire for power

Greed, hubris and the desire for power

I

Experience and Education

Experience

Experience and Education

J

Crisis Mismanagement ( MG )

K

Politicss

Politicss ( MG ) ( Enron )

cubic decimeter

Culture and Environment ( AIB ) ( SG )

Inappropriate

Hazard Culture

Culture ( Enron )

m

Lack of Transparency

N

Myths about derivative usage

O

Management Influence

P

The size of a house and the interconnectednesss

Q

Inappropriate tools and techniques

The Survey

The study had 9 subdivisions, 8 subdivisions holding closed-ended inquiries and 1 open-ended remark box and the last subdivision holding 2 open-ended remark and recommendation boxes. It was administered chiefly to participants who were members of the professional web ‘linkedin ‘ utilizing an on-line study ( on free online beginning Kwiksurvey ) . The informations obtained from the closed-ended inquiries was analysed utilizing quantitative techniques, specifically descriptive statistics such as mean and standard mistake of the mean, factor analysis and binary logistics. The informations obtained from the open-ended remark and recommendations boxes ( 52 participants from the 420 ) was analysed qualitatively, utilizing the propositions/issues generated after reading the literature for the instance survey instrument ( Yin, 2003 and Stake, 1995 ) and themes/codes when analyzing them thematically ( Braun and Clarke, 2006 ) ( Lofland et al. 2006 ) . The major findings that resulted from the closed-ended study can be summarised as follows: –

The 420 international users and accountants that participated in this survey position derived functions as utile fiscal instruments that are good to houses provided that the appropriate constructions and controls are in topographic point to combat abuse.

The assorted facets of safe derivative usage that have been identified in the derived functions literature could be grouped into six separate dimensions or factors ; viz. , Factor 1 = ‘use of hazard direction controls ‘ , Factor 2 = ‘awareness of hazards and expertness in utilizing derived functions ‘ , Factor 3 = ‘misuse of derived functions ensuing from greed, political relations and inappropriate criterions, controls and control, constructions ‘ , Factor 4 = ‘knowledge of the impact of utilizing derived functions ‘ , Factor 5 = ‘perception of utility of derived functions ‘ , and Factor 6 = ‘hindrance from misconceptions/myths and complexness of instrument ‘ . Together, these six factors accounted for 68.2 % of the variableness in the safe usage of derived functions.

From the five demographic variables that have been identified in the literature as of import factors that influence the risk-taking of the investing determination shaper, four produced a important chief consequence on at least one of the factor tonss. In fact, gender produced a important chief consequence on Factor 3, place held with house produced a important consequence on Factor 1 and on Factor 3, instruction produced a important consequence on Factor 2 and Factor 6, while experience with derived functions produced a important consequence on Factor 2, Factor 3, Factor 4 and Factor 6. Merely civil position did non bring forth a important consequence on any of the six factor tonss.

Factor 2 and Factor 3 emerged as the most of import forecasters in sorting whether or non a house frequently encounters trouble when utilizing derived functions, with an overall holdout truth of 74.7 % . In fact, the users and accountants from houses that frequently face trouble reported a lower degree of ‘awareness of hazards and expertness in utilizing derived functions ‘ and a higher degree of ‘misuse of derived functions ensuing from greed, political relations and inappropriate criterions, controls and control constructions ‘ .

Interview

The interview consisted of 6 semi-structured interview inquiries which were asked to 46 international participants, who either were exposed to an event of derivative abuse or had knowledge or see utilizing derived functions. The informations received from this beginning was analysed thematically utilizing qualitative methods ( Braun and Clarke, 2006 ) ( Lofland et al. 2006 ) . However, the propositions/issues ( Yin, 2003 and Stake, 1995 ) identified for the instance surveies were besides used as guidelines to circle out identified codes/themes ( Lofland et al. 2006 ) .

Besides in this instance, the participants were really clear on the fact that the existent job is non of derived functions and reached similar decisions to the instance surveies and the study, that the jobs have been caused by the deficiency of acknowledgment of the factors identified to hold an consequence on derivative safe usage and by the manner they are handled.

Table 5.2 Survey open-ended Questions, Interview and Literature – Factors act uponing safe usage

Literature

Open-ended Comment and recommendation Boxs

Interviews

a

Lack of segregation of responsibilities between forepart, Mid and back offices.

Lack of segregation between the forepart, center and back offices

B

Lack of appropriate internal controls and Inappropriate accounting criterions

Inappropriate accounting criterions and ordinances.

Inappropriate accounting criterions. Lack of appropriate Control Structure and controls

degree Celsiuss

Lack of appropriate supervising

vitamin D

Lax regulators and policies

Inappropriate accounting criterions and ordinances.

vitamin E

Lack of Knowledge of Managers ( users and accountants )

Lack of cognition and experience ( expertness ) on/with derived functions

degree Fahrenheit

Lack of Communication

Lack of Communication

g

Complexity and perceptual experience of the utility of derived functions

Complexity of Derived functions

Complexity of Derived functions

H

Greed, hubris and the desire for power

Greed, hubris and the desire for power

I

Experience and Education

J

Derivative by nature may ease abuse

K

Fictional characters and features of the users and accountants of derived functions

cubic decimeter

Dehumanization of the Financial Markets

Meter

Fraud and Rogue bargainers

Nitrogen

Excessively large to neglect outlook – Incorrect Percept

Oxygen

Lack of clear operational processs.

Phosphorus

The environment and civilization

The environment and civilization

Q

Fear of looking stupid

Fear of looking stupid – Malaise with Derived functions use

Roentgen

Lack of focussed accountants ( Auditors, Hazard Directors and Compliance Officers ) –

Second

Inappropriate preparation and deficiency of handiness of it.

Politicss ( Internal ( P ) and External ( P ) )

What are the regulating factors that influence the safe usage of derived functions?

Below is a sum-up of the findings from all beginnings of informations for the survey. Internal Controls, Standards, Knowledge, Understanding, Awareness, Complexity, Greed, Hubris, desire for Power and Perception of the utility of derived functions were those factors which were highlighted by all beginnings. The writer grouped these under three separate Propositions/Issues/Themes/Codes ( B, E and G ) .

Table 5.3

Proposition/Issue/Theme/Code- Factors set uping safe usage of derived functions

Case Studies

Survey

Open/Closed inquiries

Interviews

Literature

A

Lack of segregation of responsibilities between forepart and back offices.

a?s

a?s

a?s

Bacillus

Lack of appropriate internal controls and Standards

a?s

a?s

a?s

a?s

C

Lack of appropriate supervising

a?s

a?s

Calciferol

Lax regulators and policies

a?s

a?s

a?s

Tocopherol

Lack of Knowledge, understanding and awareness ( of effects of derivative usage ) by Managers ( users and accountants )

a?s

a?s

a?s

a?s

F

Lack of Communication

a?s

a?s

a?s

Gram

Complexity and perceptual experience of the utility of derived functions

a?s

a?s

a?s

a?s

Hydrogen

Greed, hubris and the desire for power

a?s

a?s

a?s

a?s

I

Experience and Education

a?s

a?s

Joule

Politicss

a?s

a?s

a?s

K

Inappropriate Culture and Environment

a?s

Liter

Lack of Transparency

a?s

Meter

Myths about derivative usage

a?s

a?s

Nitrogen

Management Influence

a?s

Oxygen

The size of a house and the interconnectednesss

a?s

Phosphorus

Inappropriate tools and techniques ( hazard Management controls )

a?s

a?s

Q

Nature of derived functions

a?s

Roentgen

Fictional characters and features of the users and accountants of derived functions

a?s

Second

Dehumanization of the Financial Markets

a?s

Thymine

Fraud and Rogue bargainers

a?s

Uracil

Lack of clear operational processs.

a?s

Volt

The environment and civilization

a?s

a?s

Tungsten

Fear of looking stupid

a?s

a?s

Ten

Lack of focussed accountants ( Auditors, Hazard Directors and Compliance Officers ) –

a?s

Yttrium

Inappropriate preparation and deficiency of handiness of it.

a?s

Omega

Excessively large to neglect outlook – Incorrect Percept

a?s

a?s

Aa

Black-Scholes Formulae

a?s

5.3 Is the job the derivative instrument itself? Should derivative usage be considered lunacy? Are they so bad and unsafe?

The writer borrows the analogy of Jorion ( 1995, p3 ) “ Derivatives – Tools of the Devil ” to explicate in a similar mode to him, the perceptual experience about derived functions ( “ the awful D word ” ) . They have been defined by some writers “ as illustrations of capitalist casinos and deadly toxicant for an already helter-skelter fiscal market ” ( Burns, 1998 ) . Jorion ( 1995 ) , highlighted that “ the word derived function appeared in Wall Street Journal headlines merely 8 times in 1992 ; in 1993, it appeared 28 times ; in 1994 128 times. ” A google hunt of the word returned 28,800,000 consequences as at 26th November, 2010. A hunt, on the same twenty-four hours, for ‘Derivative Debacles ‘ returned 131,000 consequences. Derived functions, has been progressively splashed around on the media and its usage has mushroomed globally over the last two decennaries.

Although in the instances chosen to analyze deeper, it seems that derived functions was the common denominator, it has been revealed that other factors have been put in drama to assist do the fiascos. The determination ( interviews, study ) have revealed that derived functions are of import for houses and every bit noted above supply a agency of take downing costs by enabling better hazard direction. The result of the survey has besides revealed that derived functions, given the perceptual experience, myths and misconceptions was as a convenient ‘scape caprine animal ‘ together with ‘rogue bargainers ‘ to conceal the duties of others such as Hearers, Top Management, The Boards of Directors, Audit commissions, Regulators to advert a few. It is merely in the instance of ‘Enron ‘ ( from the instances studied in dept by the writer ) that the hearers, Arthur Anderson went down with direction for the incorrect behaviors. In all other instances ‘rouge trading ‘ was blamed as a effect of derivative usage. In fact, during the interview ‘Nick Leeson ‘ , flatly refuses to fault derived functions and blames the human facet behind them and environment environing their usage. He considers them as good and of import for the growing of houses and states and riddance of hazards.

5.4 Summary of Solutions presented

The beginnings of the survey have provided the undermentioned solutions/partial solutions and recommendations for safe usage of derived functions:

The forepart, in-between, and back office should be physically and logically separate.

Training should be regular and forthcoming so as to guarantee that the trades undertaken are understood. Training should be given to accountants and users, together if possible and should associate to both controls and new merchandises.

Policies should be draw-up to be flexible, with exclusion processs.

The civilization should be changed to one where everyone within the house is responsible for controls and safe use of derived functions.

Firms need to make down in their pockets to pull the best and experienced, particularly in controls.

Policies should necessitate that merely those merchandises which staff has been trained upon and which have been understood by all can be used ( list of sanctioned instruments ) .

Communication between top direction, staff and the audit commission should be more extroverted. Communication lines should be clearly understood and effectual.

The usage of exchanges should be encouraged and OTC trades should be carried out merely utilizing standardised and understood contracts.

The hazards when transporting out OTC contracts should be clearly understood by both accountants and users and managed and accounted for suitably.

The civilization within a house should let and promote designation of defects in a similar mode as it encourages net income devising. ( e.g. they should promote the devising of net incomes with the lowest hazards and non merely pay out committees for net income )

5.5 Recommendation for Further Studies

This survey has shown that there is a manifold of factors ( six facets and four demographic variables were noted from the study entirely and 25 factors were highlighted after analyzing all beginnings of informations ) that impact on the safe usage of derived functions. Therefore, it would besides be interesting to analyze the characters and properties of the accountants and bargainers within those houses that have suffered losingss or failures through the usage of derived functions. What was the function of the structural factors in these incidents? Such surveies should assist in polishing the pick of employees, in placing the preparation they require and in planing audits for such houses. There is besides a demand to understand why warning marks were non brought to visible radiation in clip to avoid the calamities. Could this be due to the size of the accountant ‘s squad, the inappropriate construction or due to the describing lines/communication of the lines of defence? There is demand for farther research to turn to these jobs and to look into through empirical observation and inductively with a position to research possible accounts. Such research will bring forth more information than is presently available. Besides, one needs to travel deeper into other instances such as the hedge financess of LTCM and Amaranth, to understand consequence these factors act uponing the safe usage of derived functions have on them. In fact, a factor noted from LTCM did non characteristic in the other instances studied – the Black-Scholes expression.

Premises and restrictions of the survey

This survey is limited to the individuals and instances from the selected mentioned above and the study is skewed towards participants on Linkedin, hence restricting the generalisability of the research findings.

The tools ( questionnaires/survey/cases and literature ) are designed by the research worker and has merely face cogency.

The study was based wholly on responses from a self-report questionnaire. Therefore, it was assumed that respondents are capable of an acceptable grade of evaluation with preciseness and objectiveness. It is possible that some respondents might hold presented themselves in what they consider to be a positive mode and this might bias to some extent the consequences ( Saunders et al. , 2007 ) .That is there is ?° potency for prejudice in the responses to the studies participants due to the possibility that more satisfied or disgruntled persons may hold returned completed questionnaires.

This is besides a possibility in the interviews since they were chosen by the writer purposively and because of convenience.

There is a possible prejudice in the consequences and decision because of the research workers skewing towards linkedin participants.

Since the trying frame of the population considered was non available ( due to the Data Protection ) , the research worker used a combination of purposive and snowball sampling techniques. This means that the sample elements are non needfully representative of the mark population ( californium. Hair et al. , 2007 ) .

In malice of the restrictions, the present findings contribute to the on-going argument refering the usage and abuse of derived functions and could perchance promote more research surveies to be conducted in order to progress our apprehension of the safe and efficient usage of derived functions.

It is besides assumed that the information beginnings that are used within the surveies are dependable and is valid informations. Furthermore, the participants are intentionally selected from individuals that are experiences and knowing in derived functions and the most representative ( in the writer ‘s sentiment ) instances of derivative abuse are chosen. There are, still, certain restrictions to this survey because it is focused on accountants, users of derived functions, bookmans, instances and literature chosen by the research worker. One major beginning of confusing arises from non-random forms in the rank of participants in the survey and the instances chosen or within groups in the survey. This can impact internal and external cogency in ?° assortment of ways none of which are needfully predictable. It is frequently merely after making ?° great trade of work that the research worker may detect that some bug in the processs or some inadvertence has rendered the consequences un-interpretable.

Contributions of the survey

Surveies on derived functions over the last decennaries have been eternal. However, each tackled different countries taking similar or different attacks or looking at different parts or states. The writer was nevertheless, unable to happen other surveies that analysed the issue of abuse of derived functions in the same mode and attack as this survey.

This survey, contributes to the increasing organic structure of literature on house failures and losingss attributed to derived functions and the controls in this. It helps place those of import factors which users and accountants need to be cognizant of and recognize when prosecuting with derived functions. In making this, the survey breaks the myth environing derived functions and house failures by saying that derived functions are an indispensable corporate tool when decently used to fudge against hazard. Since derived functions myths still condition the heads of direction and corporate managers, a farther survey was needed so as to develop ways of educating them on derived functions.

This survey is focused on placing clear controls to guarantee derived functions can be used in a safe mode and at the same clip be good to the relevant parties. The writer besides takes the stance of a research worker practician ‘s position. This as has already been noted in the old chapters, helps lend to the practical portion of this survey conveying academe and world closer to each other.

5.8 Drumhead

Derived functions are a cardinal instrument used in pull offing concern hazards. However, these are subjected to mistreat and use when proper control mechanisms are non in topographic point. Furthermore, the nature and type of the derived functions used should depend on the hazard being faced. The different contexts upon which derived functions have been used and the use and deceitful minutess all gave valuable lessons that contribute to the better apprehension of these fiscal instruments. More so, the hereafter of derived functions entails an ageless possibility that makes it more profitable and continuously enhances its place and usage in the fiscal markets. Therefore, it has been proven that there is a great possible hidden among the derived functions and it is of import to go cognizant of the hazards associated with its abuse for success to be achieved in trading with these instruments.

The survey analysis made it clear that there are a figure of factors which impact the safe usage of derived functions. Besides, it has been noted that ordinances and controls are established once the consequences of historical occurrences are studied, investigated and understood. Therefore, they are reactive and at times may be out of touch with the new worlds. So, the reply to safe usage of derived functions is a affair of a figure of issues taken together. Firms and establishments should recognize these and remain on the qui vive for any alterations and invention that can be necessitating of new controls.

To guarantee that derived functions are used safely by houses, is a unrecorded thing, and one has to return to the pulling board and rethink how to extenuate identified factors. Until this universe of derived functions is surrounded by “ Angels ” , houses and establishments, involved with derived functions, should stay on the qui vive for ‘red flags ‘ and look out for the following smart user who could blindside controls.