Demystifying Derivatives Warren Edwardes ceo Delphi Risk Management

Demystifying Derivatives Warren Edwardes ceo, Delphi Risk Management Limited Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

Author of • Key financial instruments: – understanding and innovating in the world of derivatives Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 2

Famous cases: • Barings – founded in 1763 – crashed through lack of control of derivatives Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 3

Famous cases: • Equitable Life – founded in 1762 – crashed through not using derivatives to manage interest rate risk – boards have been successfully sued for not using derivatives to manage risk Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 4

So what’s a derivative? • a financial market derivative instrument is derived from other cash market instruments or other derivatives. • the majority of financial instruments are not new instruments. • They are merely combinations of derivatives and/or standard cash market instruments • the building block approach Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 5

Examples of derivatives - commodities • orange juice futures Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 6

Examples of derivatives - commodities • Oil • futures have liquid trading • homogenous product Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 7

Examples of derivatives - commodities • Coffee • a liquid market • fairly standardised Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 8

Examples of derivatives - commodities • wine ? ? • Not homogeneous • not customer needs driven • Paris market unlikely to survive Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 9

Examples of derivatives - commodities • property / real estate ? ? • Not homogeneous • FOX property market failed in 1991 Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

Examples of derivatives - shares? • A share is an option on the assets of a firm Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

Examples of derivatives - retail financial products • foreign exchange notes Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

Examples of derivatives - retail financial products • fixed rate mortgages Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

Examples of derivatives - retail financial products • equity index linked savings Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

Examples of derivatives - retail financial products • Insurance? Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

4 key financial building blocks • spot – the now contract - like exchanging Pounds for Pesetas in the high street • forward – you could buy your Euros in the forward market; payment and delivery next year. • deposit – you could borrow money, buy the Euros now (spot) and deposit the Euros. • option – Equitable Life gave interest rate guarantees - but didn’t manage the risk! Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

Conclusion: what’s a derivative? • a financial market derivative instrument is derived from other cash market instruments or other derivatives. • the majority of financial instruments are not new instruments. • They are merely combinations of derivatives and/or standard cash market instruments • remember the building block approach Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

And finally! • Beware of insider trading • underlying price manipulation – credit derivatives • terrorists selling put options on American Airlines! Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1

Demystifying derivatives by Warren Edwardes Demystifying Derivatives Warren Edwardes we@dc 3. co. uk 1