The advantages of financial derivatives are obvious: they give an organization access to a market or asset that is otherwise unavailable. Interest rate swaps, for example, offer a better interest rate than direct borrowing. However, there are also significant drawbacks of these instruments. The Global Financial Crisis of 2007-2008 exposed the world to disastrous consequences as the rapid devaluation of credit-default swaps and mortgage-backed securities caused the collapse of numerous banks and securities around the world. The high volatility of derivatives makes them difficult to value and exposes organizations to huge losses.
Disadvantages of Financial derivative
Although financial derivatives are a great way to make a profit, they can also bring significant financial difficulty. Even if they are a good investment, the wrong use of these instruments can lead to huge losses. Recently, five or six Indian small firms sued private sector banks for mishandling derivatives. One of the banks was found responsible for losing ten million dollars on derivative instruments. Companies can also suffer large financial costs when they make an incorrect forecast about foreign exchange rates or commodity prices.
The advantages of financial derivatives are many. Besides providing a steady income, they can help stabilize costs and maximize sales profits. The risks associated with financial derivatives are considerable. They can lead to bankruptcy, if used inappropriately. The cost of a financial derivative is greater than the capital invested in it. For these reasons, it is a good idea to seek the advice of a financial expert before engaging in any financial transactions.
A well-designed financial market can be more efficient. As long as the derivative contract replicates the payoff of the underlying asset, it prevents arbitrage opportunities in the market. Because the global financial markets are vast, financial derivatives can give a company access to assets and markets that otherwise are unavailable to it. A good example is interest rate swaps, which allow companies to borrow at better interest rates than they would otherwise be able to get.
While financial derivatives can be beneficial for small companies, they also have some disadvantages. When used properly, they can increase a company’s reputation and help it enter the finance industry. Moreover, it can train a management team to handle complex finance issues. The disadvantages of financial derivatives include huge losses and, in some cases, even bankruptcy. So, before using financial derivatives for your business, make sure you know the pros and cons of them.
The financial advantages of financial derivatives are numerous. In addition to predicting the future price of a product, they can also stabilize costs and maximize sales profits. Furthermore, they help a company predict the price trend of raw materials. This is a major advantage of financial derivatives. If you are considering using them for your business, you should carefully consider the disadvantages and the benefits of these types of investments. The main disadvantage is that they do not guarantee success.