Financial derivatives Essay Example | Topics and Well Written Essays - 750 words

Financial derivatives - Essay Example While common types of derivatives include assortment of financial contracts which are; Future contracts, options, deposits, forward contracts and swaps. However, derivatives are categorized into three main parts including financial instruments, equities (stocks and shares) and debt (mortgages and bonds). Foreign exchange risk is the risk embodied to earnings or capital arising from change of foreign exchange rates. Foreign exchange risk is related to cross- border investing and operating activities. Position-taking and Market-making in foreign currencies should be placed under price risk. Foreign exchange risk is also branded as translation risk. The risk ascends from holding accrual accounts with foreign denomination currency, including bonds, debts and deposits. This also embodies foreign currency denominated derivatives such as structured deposits, synthetic investments, structured notes, and off-balance-sheet derivatives used to mitigate accrual exposures (Shim & Siegel, 2008). Accounting conventions need periodic revaluation of these accounts at current exchange rates. Periodic revaluation decodes the foreign- denominated accounts into U.S. dollar currency. Banks should record these accrual-based products under appropriate systems that detect, calibrate, monitor, and regulate foreign exchange exposure. This may be useful to banks in managing Foreign exchange risk (Shim & Siegel, 2008). Financial derivatives are used either for management of risk i.e. hedging risk by provision of compensation in case of unwanted situation arbitrage between markets. Derivatives can be used for speculation purposes i.e. making financial bet. This difference is vital because risk management is a discreet aspect of financial management and operations for a lot of companies across different industries while speculation purpose offers managers and investors a risky chance to increase profit, which may not be revealed appropriately to