Derivatives

Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security or index. Their value can be affected dramatically by even small market movements, sometimes in unpredictable ways.

There are many types of derivatives with many different uses. They do not necessarily increase risk, and may, in fact, reduce risk.

More exotic financial products include derivatives such as:

Options: certificates that give the right to buy specific securities at a given price up to a certain point in the future;

Futures: a futures contract is a contract to buy something like a given quantity of a commodity or a certain number of securities for delivery at an agreed time in the future at a price agreed now;

Swaps: for instance, a borrower agrees to exchange a fixed interest payment on a loan with another borrower’s variable interest payments, each borrower thus making the type of payments that suits them better.

A Distracting Side Show

Mario Gabelli, a star of the investing world, says, “My gut says the negatives of derivatives far outweigh the benefits.” Like others, Mr. Gabelli says that if futures cause investors to lose confidence in stocks, they will move away from stocks – as many others have already done. And those who remain, he says, will demand a higher return and over the time raise the cost of capital to companies.

Essentially, the critics of stock index futures fall into two camps. One group says the futures contribute to stock market volatility; the other contends the futures are side show of speculation that detracts from the stock markets’ basic function of raising capital.

“Before futures,” says New York investor Michael Harkins, “you actually had to pay attention to whether the thing you were buying had any intrinsic value.” While it was once expected that futures would mimic stock prices, traders now routinely check the futures markets in Chicago before they buy or sell stocks. When Chicago jumps up or down, the New York Stock Exchange follows.

On Tuesday, for instance, the Dow Jones Industrial average plunged 80 points in little more than an hour. Then, in the space of a 20-minute coffee break, the average rallied almost all of the way back.

Paul Lesutis, who manages more than $3 billion of investments at Provident Capital Management Inc., blames the futures markets for leading the way. “The fundamentals don’t change in an hour,” he says. “I think they should close down the futures exchange and then we could get back to investing.”

Notes

1. my gut says – I feel it instinctively

2. cost of capital – стоимость капитала: стоимость финансовых ресурсов, используемых в результате принятия инвестиционного решения

3. stock index futures – фьючерсные контракты на основе фондовых индексов

4. futures markets in Chicago – Chicago Board of Trade, Chicago Board Options Exchange, Chicago Mercantile Exchange

5. interest rate swap – процентный своп

6. side show – что-то, отвлекающее внимание от основного события или деятельности