I am trying to formulate my opinion about our current economic issues. One variable I can't grasp is the financial derivatives market and what will unwind as a result of recent events.
I just read the Wikipedia page on financial derivatives:
Derivative (finance) - Wikipedia, the free encyclopedia
Warren Buffet has been warning of the potential risks of these financial products for over 5 years:
The next type of financial product (derivative) that has been showcased in the recent economic turmoil are credit derivatives, mainly credit default swaps which are basically insurance contracts used to hedge against an entity defaulting (going bankrupt). Wikipedia says this the largest of the derivative markets worth $42 trillion in 2007.
Companies buy other types of derivatives such as foreign exchange derivatives to hedge against currency fluctuations. As seen in this article, Sadia of Brazil was caught in this and will have to cover over $400 million for using these products as part of their strategy:
Basically what I am trying to understand is what's going to happen to this huge unknown/unregulated slice of the world's economy? Based on recent events how will those stuck holding the default swaps for failed (or failing companies pay up)? What other derivative types are there and how will this whole market unwind?
When it comes to derivatives what risks are ahead? Is there a potential of huge defaults from outside the banking industry by owners of these financial products?
I just read the Wikipedia page on financial derivatives:
Derivative (finance) - Wikipedia, the free encyclopedia
Warren Buffet has been warning of the potential risks of these financial products for over 5 years:
In recent months we have learned about banks exposures to the mortgage backed derivatives. This product I find easy to understand, it's just a grouping of mortgages who's borrowers had a similar credit rating at the time of issuing the mortgages. Entities could then buy these financial products (derivative) for various business reasons. These are typical of the toxic assets owned by banks that are currently being addressed by the global government bank bailouts."hell... easy to enter and almost impossible to exit" (Article)
The next type of financial product (derivative) that has been showcased in the recent economic turmoil are credit derivatives, mainly credit default swaps which are basically insurance contracts used to hedge against an entity defaulting (going bankrupt). Wikipedia says this the largest of the derivative markets worth $42 trillion in 2007.
Companies buy other types of derivatives such as foreign exchange derivatives to hedge against currency fluctuations. As seen in this article, Sadia of Brazil was caught in this and will have to cover over $400 million for using these products as part of their strategy:
From what I read these derivatives are really something to be worried about. Sure the banking system might be saved through government bailouts (as announced over the weekend) but is that like giving CPR to a person who is months away from dying of cancer? Obviously you have to take first steps first and try to keep the patient alive day by day but is death [SIZE=-1]imminent[/SIZE]?The company said it bought foreign exchange derivatives in excess of its need to cover export operations, contributing to losses that surpassed its 2007 profit of 689 million reais.
Sadia says it covered derivatives, Lehman loss | Industries | Consumer Goods & Retail | Reuters
Basically what I am trying to understand is what's going to happen to this huge unknown/unregulated slice of the world's economy? Based on recent events how will those stuck holding the default swaps for failed (or failing companies pay up)? What other derivative types are there and how will this whole market unwind?
When it comes to derivatives what risks are ahead? Is there a potential of huge defaults from outside the banking industry by owners of these financial products?