A derivative is described as a price that is formulated based on the value of underlying assets. It is described as a security against the fluctuations in the economy. Wilmott (2013) describes it as a form of contract that is established between two parties based on the value of the underlying assets. The fluctuations in the value of the underlying assets determine the derivative value. Such assets include currencies, interest rates, bonds, and stocks. Derivatives are of the essence in cases of fluctuations or adverse events. Therefore, the have a significant impact both negative and positive to our current economy.
Chance and Brooks (2015) explain that derivatives can be seen to be factors that minimize economic crisis in that their significance in reducing uncertainty is very relevant in avoiding the undesirable economic changes that might occur. As such, derivatives can be used to avoid the negative implications that accompany changes brought by the fluctuations. Different prices of commodities such as crude oil keep fluctuating. However, deviates ensure that the prices do not highly deviate from the agreed prices. As such, this helps avoid the economic crises that may arise in case there is a shortage of such products. “For any stored asset, the spot price is related to the expected future spot price…this relationship is used to explain future pricing” (Chance and Brooks, pp. 289). Therefore, derivatives are of the essence in stabilizing the economy in cases where the future profits and prices are unpredictable. In essence, derivatives are vital in the economy for mitigating many risks that would give rise into big economic crises.
The extent of which derivatives can fuel the current economic woes can be estimated by the danger expressed in the less transparency of accounting statement and the reliability revealed (Wilmott, 2013). Managing the derivatives might at times be sophisticated hence accounting for some derivatives may be conducted which implicates an adverse effect on the economy. In some cases, the involved traders may consent on the price of the traded derivatives, but their agreement may vary in case of illiquid securities. As such, the derivatives are priced differently by numerous enterprises which lead to the fluctuations experienced in our current economy. In essence, derivatives can be seen to be a contributing factor to the economy crisis.
References
Chance, D. M., & Brooks, R. (2015). Introduction to derivatives and risk management. Boston: Cengage Learning.
Wilmott, P. (2013). Paul Wilmott on quantitative finance. New Jersey: John Wiley & Sons.
