Business Finance Assignment

Assignment Topic:           

-      Derivatives serve an important function of the global financial market place, providing end-users with opportunities to better manage financial risks associated with their business transactions.  The rapid growth and increasing complexity of derivatives reflect both the increased demand for end-users for better ways to manage their financial risks and the innovative capacity of the financial services industry to respond to market demands.  Discuss (at least 10 pages).

-      In March 2012, a study by the senate committee on technology assessment entitled “Electronic Bulls & Bears: Nigeria Securities Markets and Information Technology included this statement:  Securities market have five basic functions in a capitalistic economy;

1. They make it possible for corporations and government units to raise capital

2. They help to allocate capital towards productive uses

 

3. They provide an opportunity for people to increase their savings by investing in them

4. They reveal investor’s judgements about potential savings capacity of corporations, thus giving guidance to corporate managers and

5. They generate employment and income

For each of these function cited above, explain how financial markets (or securities market) perform each function.

SOLUTION:

 

INTRODUCTION

Many associate the financial market mostly with the equity market. The financial market is, of course, far broader, encompassing bonds, foreign exchange, real estate, commodities, and numerous other asset

classes and financial instruments.

A segment of the market has fast become its most important one: derivatives. The derivatives market has seen the highest growth of all financial market segments in recent years. It has become a central contributor to the stability of the financial system and an important factor in the functioning of the real economy.

Despite the importance of the derivatives market, few outsiders have a comprehensive perspective on its size, structure, role and segments and on how it works. The derivatives market has recently attracted more attention against the backdrop of the financial crisis, fraud cases and the near failure of some market participants. 

Although the financial crisis has primarily been caused by structured credit-linked securities that are not derivatives, policy makers and regulators have started to think about strengthening regulation

to increase transparency and safety both for derivatives and other financial instruments.

Derivatives are an important class of financial instruments that are central to today’s financial and trade markets. They offer various types of risk protection and allow innovative investment strategies. Around 25 years ago, the derivatives market was small and domestic.

Since then it has grown impressively – around 24 percent per year in the last decade – into a sizeable and truly global market with about N957 trillion of notional amount outstanding.

No other class of financial instruments has experienced as much innovation. Product and technology innovation together with competition have fuelled the impressive growth that has created many new jobs both at exchanges and intermediaries as well as at related service providers. As global leaders driving the market’s development, European derivatives players today account for more than 20 percent of the European wholesale financial services sector’s revenues and contribute 0.4 percent to total European GDP.

Given the derivatives market’s global nature, users

can trade around the clock and make use of derivatives that offer exposure to almost any “underlying” across all markets and asset classes. The derivatives market is predominantly a professional wholesale market with banks, investment firms, insurance companies and corporate as its main participants.

There are two competing segments in the derivatives

market: the off-exchange or over-the-counter (OTC)

segment and the on-exchange segment. Only around

16 percent of the notional amount outstanding is

traded on exchanges. From a customer perspective,

on-exchange trading is approximately eight times

less expensive than OTC trading.

By and large, the derivatives market is safe and efficient. Risks are particularly well controlled in the

exchange segment, where central counterparties

(CCPs) operate very efficiently and mitigate the risks

for all market participants. In this respect, derivatives have to be distinguished from e.g. structured credit linked security such as collateralized debt obligations that triggered the financial crisis in 2007.

The derivatives market has successfully developed

under an effective regulatory regime. All three prerequisites for a well-functioning market – safety,

efficiency and innovation – are fulfilled. While there

is no need for structural changes in the framework

under which OTC players and exchanges operate today, improvements are possible. Particularly in

the OTC segment, increasing operating efficiency,

market transparency and enhancing counterparty

risk mitigation would help the global derivatives

market to function even more effectively.

for complete assignment, visit www.researchshelf.com