Abstract

The answer to the question of whether derivatives are speculative instruments or whether they are useful risk-management tools depends on how they are used and for what purpose. There is no doubt that many investors take financial positions in a manner that reflects their views about potential market changes. In some instances, this may be viewed as prudent risk management; however, such positioning can also be speculative. To say, therefore, that derivatives should be prohibited simply because they can be used for speculative purposes is an anomaly for many financial institutions that are involved in a number of risk-taking activities, one of the biggest of which is lending their money to others. One of the things that the Office of the Comptroller of the Currency (OCC) has found by tracking the exposures—specifically, credit exposure—of some of the largest banks is that, as large as derivatives activities have grown, the exposure on credit card loans was much greater than the exposure from derivatives. Nevertheless, derivatives are generally perceived as very risky. The revenues that flow from derivatives are volatile, but, in fact, the greater risk—and thus the potential for greater loss—is still associated with lending out a bank’s own money.