Financial services ( Derivatives ) Essay Example | Topics and Well Written Essays - 1750 words

Financial services ( Derivatives ) - Essay Example In United Kingdom, derivatives can be traded by two methods: either through an over-the-counter (OTC) or organised exchange. The exchange traded derivatives market is controlled by Chicago Mercantile Exchange and Euronext.LIFFE that is based in London. Exchange traded derivatives are always bought and sold in an exchange setting that is totally regulated and transparent. On the other hand, OTC exchanges takes place when trader prefer to trade directly with each other. Between both types of trade, there are two main differences: Firstly, exchange traded contracts increases liquidity. Secondly, traders enter into a contract through the exchange clearing house which gives them a guarantee that the contract will be adhered to. Over-the-counter trade do not have that lavishness because there is always the risk that one of the contractors will fail to honour the original agreement thereby going into liquidation (Reid, 2013, p.1). This paper will focus on the list of bank and companies maki ng losses from using derivatives and what are the risks and benefits of different types of derivatives contracts. Bank and Companies Exposed to Losses There are some banks and companies which are exposed to losses due to derivative contracts. ... The financial disorder with its rigorous liquidity and credit crunch seemed to detain to financial markets and institutions in the UK. It resulted in the failure of the key businesses, downturn in the economic activity and reveals a quick drying up of liquidity following a huge expansion in credit issued to consumers and financial institutions. Metallgesellschaft AG engaged in a wide range of activities from engineering to trade and mining and financial services. The firm was exposed to large derivatives related losses at its U.S. oil subsidiary which is known as Metallgesellschaft Refining and Marketing. It had accounted a loss of $1 billion. Metallgesellschaft AG losses were attributed to its wrong hedging program. Risk of Derivative Contracts Risks associated with derivatives are market risk, credit risk, counterparty credit risk, transparency risk, legal risk and basis risk. Counterparty Credit Risk It is the risk that a party to a derivative contract will be ineffective to perfo rm on its obligation. AIG tinted weakness in the supervision of counterparty risk and thus less clearable, OTC derivatives. AIG’s counterparties had decided to only require collateral to cover counterparty risk of American International Group if AIG were downgraded. When American International Group did experience the difficulties simultaneous liquidity squeeze and collateral calls at AIG resulted in its ultimate bail-out to evade systemic outcome. Posting to collateral either through upfront margins or mark-to-market margins is used to minimise counterparty risk to which they are exposed (Fsa, 2009, p.5). Transparency Risk The bankruptcy of Lehman Brothers tinted that positions and disclosure of firms in OTC derivative market were