Defending Derivatives: WSJ article gives the market a reality check on the proper use of derivatives

Apr 7, 2009

WSJ article gives the market a reality check on the proper use of derivatives

Too often derivatives are blamed for the financial crisis but such criticism often comes from those with little knowledge of how derivatives are used. Below is a great WSJ article which spells out the proper use of derivatives and how the financial market can create a more supportive and safer market structure to support the ongoing use of derivatives. See details and link for article below.

In Defense of Derivatives and How to Regulate Them

The much-maligned financial instruments have legitimate uses

By René M. Stulz

The dictionary defines a derivative in the field of chemistry as "a substance that can be made from another substance." Derivatives in finance work on the same principle. But if you read the headlines these days, you might think derivatives were made from arsenic by Wall Street institutions bent on causing financial destruction.

There are two sides to derivatives -- one positive and beneficial, one exploitive and negative. Of the latter, the most visible example today comes to us courtesy of the American International Group (AIG) and reveals what happens when a lightly regulated but highly interconnected financial institution ends up positioned in a way that it cannot survive a housing crash and then such a crash occurs.

The other side of derivatives, however, involves the less-publicized but widespread use of these financial instruments in ways that benefit companies. Derivatives have been immensely valuable tools and will be instrumental in providing the liquidity needed to jump-start the economy. Derivatives are used by a vast number of U.S. companies, both small and large, to manage various risks that arise in connection with their businesses.

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