A Close Up On Financial Derivatives And Ethics Finance Essay - Free Essay Example

This financial term is draw from the word derive which indicates to get or obtain something so in other words we can say that: It is a financial instrument that has value determined by the future price if something else. It is something like a bet on future price of a product. Derivative is an agreement among two parties in which value of anything is speculated by comparing it to the value of another agreement already done and same like that. It is speculation of future. To understand the derivatives two things are more important. First of all that it is a contract which is based on primary contract whereas secondly its values are obtained from initial agreement which are done before from that? Therefore the worth of derivatives does not remain same because these are linked to the fundamental agreement. So we can say that it is a contract in which a person guesses the value of a thing for future by analysing its past worth. Historical background The histor y of this phrase is very old as Aristotle discussed in his book politics The story of Thales of millet who was a good analyst of weather. Thales borrowed the pressers of Olives because he analysed that as next crop will give a good product. He hired all pressers in a little price at time of harvest. The crop of olives was copious and now everybody has desired to borrow the presser but as the Thales has all right reserved so it is impossible to get for anyone. Aristotle wants to tell in this story that it does not matter that the good thinker is a good business man but as it is a good example can be considered for derivatives. Thales spent a small money as he didnt buy the presser just buy their rights only to use them. It is due to his speculation that he spent a bit and its profit was a massive amount. So he had taken a good risk by his speculation. So it is resulted that the major element of derivatives are a small investment, massive profit and have a good knowledge for that t hing and a good speculation power for future. In this example we have just seen the single part of derivatives which is speculation whereas the major purpose of derivatives is Hedging. At this time derivatives perform as an assurance device. As here we can give the example of farmer who didnt know about the weather conditions and fully depends on God and sells his corps fine earlier than definite occasion of harvesting and transfer all the threats towards purchaser. Purchaser gives the money to cultivator so he gets less money but his all risks are finished. As according to the history of derivatives we examined that it is started off cultivation sector. That people make contracts for next year harvest on the value of its previous years. First actual financial derivative was started in 1970 in Chicago Future Market by making contracts with US government. And in 90s fiscal destabilises, improvement into equipment and knowledge of goods has given a turn to derivatives into econo mic achievement stories. And now according to IMF report; Derivatives engage as much money as, North America, Japan, and 15 EU member countries combined assets of the banks, bonds and equities. The importance of derivatives is increasing in the global market day by day because you can ensure through it circle of money and prices of things around the world in just a minutes. Therefore now the derivatives have control over the economic strategies of the countries. After this discussion now it will be easy for us to express our topic that; Speculators can generate a massive wealth from derivatives but it is unethical. Now there are some words bearing great importance. Every business man has a great opportunity in the whole world in making decision due to financial derivatives. It doesnt matter that business man is a new person or an expert business man; Derivatives affects all the decisions either speculated or other factors. Usually In all dealings it is examined tha t there is a relationship who points out trust level and beliefs between the participants. And it may be getting several years to make the transaction trouble-free. Trading home status is able to obtain profit as well as benefit of such events. Simply if a company which is recognized many years ago on Wall Street might effortlessly control its complements to do business whereas it is difficult for a new business man to do so, not easy for him to get such advantages. Derivatives have different categories according to their significance, as here is a good example of comparison between Wall Street blue chip products and African Markey coffee business. So we can see that Wall Street market should be more experienced than the other one due to its electronic media and proficiencies. Ethics and financial derivatives Unpreserved food or products is also another aspect that makes fast the decision making which has increased the chance of error as such product are compared to strong mat erial. Another issue which effect the decision making that is market itself. Famous markets of developed countries like Dow Jones, FTSE as well Wall Street grasp a bleak difference as compared to less famous markets of developing states like Dalal Street Mumbai and KSE Karachi. Competition between such markets is like as a world champion team is playing with the learner team. The result must be in favour of world champion. We can see the example of UK group of trader which has a good business in London Stock Exchange in 1996 he had invested in KSE Pakistan. In few days they generated unexpected increase in the shares prices. They misplaced by massive profit while such shares were sold to the public, leaving them behind watching their investment going down. There are different type of derivatives like Vanilla derivatives are uncomplicated plus very familiar, and exotic derivatives are very difficult and hard. Here we described a number of derivatives but now we discuss the ethics. Th at now ethically derivatives are standing where? The meaning of word ethics as described in Oxford Dictionary are, a moral principle of frame work, moral principle, and discussion of these. In common words ethics is a term which discuss with morality in every business we take the constituent of greediness and profit, we speculate about profit. Hazel case It seems that there is no need of explanation about ethics that whether it is ethical or not. To explain this we have to overview of some case laws. Here the Hazel case is the most prominent case about ethics in which court decided that It is against the morality and ethics to invest public money without authorization form the public or relevant authorised body. In this case The Hammersmith council has developed a capital fund except a definite ruling and no report was given to the members about actions. And council had also not got the members in confidence. It has to face a great loss. Mrs Margret Thatcher PM of UK increased the profits rates triggering off that raised the problems of council. Judge Sir Stephen brown decided that action of council is totally illegal and unethical. He expressed in his decision that public authorities has not right to enter in business of interest rates exchanges or linked dealings. He also express that his decision is not just for this case but also any other trade or business action in which a public authority involved itself for profit. The case was triggered off as the council had the council had an important along with confidential through community. Any institution like bank which is involved unethically to guide and persuade the council for such wicked achievement, the situation become very wrong. Westdeutsche landsman vs. Islington council This case has also a great importance in derivatives first this case is viewed according to Hazel case and later on decided with a different way. In Westdeutche landsman vs. Islington council case plaintiff (bank ) made a profit rate exchange by council for a ten years contract. The deal was done is such a way that bank will pay the interest to council after every six month. It was estimated that 25 m pound is total amount which is fixed rate interest to payable by bank between the parties and 2.5 m pounds furthermore compensated through bank in contract. Now the bank entered into an equivalent swop deal with Kleinwort Benson towards evade its probable economic compulsions. And making the excuse of Hazel case council closed to pay the bank. The bank took authorized action to ask on behalf of refund of 2.5 million by interest. Judge decided that; There had been no consideration for later amount that the fund, under a parallel swap transaction provided by the bank and due to non-payment the bank began to be out of pocket. Many legal issues were different in both this and Hazel case but we cannot overemphasize the direct impact of Hazel decision on this case. Indeed councils decision to stop payment to bank was based on Hazels decision. Similarly Hazel also provides the principle and guideline for the public bodies regarding use of interest rate swap contracts. The court was mindful of Hazel case while dealing the Westdeutsche case. Control on derivatives Now the question arises that can we stop derivatives or not, so after all this discussion as we examined it is impossible to stop the derivates but adopting the following the following methods derivates can be controlled. As funds competence trading limit, release announcement, apply firm restrictions over total, assets which communal organizations be able to drop reverse in the direction of derivatives. It might be useful to control the derivatives. In the same way there is a need to impose limits over business to control the extreme reliability inside market. This method is adopted in Newyork stock exchange since 1987 and is very helpful to control the derivatives Conclusion In US and UK as we studied bo th the countries have some types of fiscal mechanisms about which we can say that these are unsafe other their more forms are very useful and have a capability to stop all the risks involved. Their governments are spending a large budget to reduce such threats and to discriminate those thoughts which are promoting by the banks. While this is a reality that there are a number of derivatives which cannot be stopped by them. The major ethics problem which is facing by nonfinancial corporations is that they have to complete that by courage. Either this instrument is helpful or not and by using this derivative can we complete our task or not. Is it useful to remove the risks or not. These are basic issues which are the major discussion topic of banks and companies, but the derivative must be forced with the help of skilled experts, also they must have a good awareness about unethical grounds of economic instruments. Now the latest examples of derivatives are huge debit of Royal Bank of S cotland and fall down of Lehman Brothers which cannot be ignored. The utilization as well as position of derivatives with full-size guns because it seems simple motivates the investors to invest their capital into market. As I concluded it should be the responsibility of government to establish a good protective system to keep away from the bribery as well as hazardous results for shareholders. So now it is clear to us that derivatives may moral for the companies as well for banks particularly if the companies have no awareness about business procedure and activities or unknown status in the market. These financial instruments are confusing and destroying honesty of established and well known companies. Government should impose the restriction on such financial derivatives and should be bound them up to traders only and they should have no access to public sector. If this is imposed by the government it would have a great positive effect on public society. Lord Anker says that; L ocal authorities should try to minimize the risk, Similarly Lord Templman said that; as local authorities are not allowed to borrow foreign currency without the authorization of treasury so they cannot carry out swap transaction. So to sum up we can say that through these financial derivatives speculators can generate massive amount of money but derivatives fall far from ethics, especially public bodies are not allowed to invest on their own the public money on basis of speculation.