Demystifying Derivatives Warren Edwardes [email protected] 1 Demystifying Derivatives Warren Edwardes ceo, Delphi Risk Management Limited

1Demystifying DerivativesWarren Edwardes [email protected]

Demystifying Derivatives

Warren Edwardes

ceo, Delphi Risk Management Limited


Author of

• Key financial instruments: – understanding and innovating in the world of

derivatives


Famous cases:

• Barings – founded in 1763

– crashed through lack of control of derivatives


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


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


Examples of derivatives - commodities

• orange juice futures



• Oil

• futures have liquid trading

• homogenous product



• Coffee

• a liquid market

• fairly standardised



• wine ??

• Not homogeneous

• not customer needs driven

• Paris market unlikely to survive

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Demystifying DerivativesWarren Edwardes [email protected]


• property / real estate ??

• Not homogeneous

• FOX property market failed in 1991

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Examples of derivatives - shares?

• A share is an option on the assets of a firm

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Examples of derivatives - retail financial products

• foreign exchange notes

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• fixed rate mortgages

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• equity index linked savings

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• Insurance?

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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!

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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

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And finally!

• Beware of insider trading

• underlying price manipulation– credit derivatives

• terrorists selling put options on American Airlines!

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Demystifying derivatives by Warren Edwardes

Documents

Demystifying Derivatives Warren Edwardes [email protected] 1 Demystifying Derivatives Warren Edwardes ceo, Delphi Risk Management Limited