Drawbacks For Using Derivatives

Introduction

The players involved in the derivative market are arbitrageurs, hedgers and speculators. Derivatives are used widely in the financial markets especially among investors who do not deal with the real market but a market in the future (Burghardt, 2011). The derivative market has both systemic and operational risk that may involve human errors in making assumptions. Another risk arises where one party may fail to meet its obligations to meet future engagements agreed between two parties. Price is an important factor in agreements between two parties especially producers and manufacturers. Since they have a fixed arrangement of selling, a rise in price would benefit the producer while a reduction in price would affect the manufacturer negatively due to high costs in paying the farmer.

Derivatives have the capability of creating markets that are more effective but can undermine the markets because they provide for a quicker establishment of positions speculatively. The easy undervaluation of derivatives greatly concern investors in additions the assumptions regarding the formulas used in derivatives do not tango with the real market situations. Tus the use of assumptions when there is no real market produces a speculation that may not be real.

Derivatives are evidenced by high risks that affect the people involved specifically the investors. Most of the people involves take the speculative risks that may lead to losses or high gains since a lot of money is involved (Schofield, 2013). Various institutions like financial companies, banks and other businesses are involved in the process and linked to the use of the derivatives in the market. Since countries are involved in the trade, there is a higher chance of them missing a lot of money and thus increasing inflation, interest rates and a grave effect on the respective currencies.


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