The questions to be asked when investing in derivatives • Which risk is inordinate? • How can a potentially limitless exposure be kept under control? The Orange county debacle underscores the need for careful management of risk in developing a portfolio of investments. Derivatives may be a hedge against other investments that have low yields but the derivatives themselves clearly entail substantial risks. Focused legislation and regulation are the answers but new derivatives legislation is not an easy issue. Investors entering into derivatives contracts understand
• The nature of the contract they are entering into and • The projection of the exposure they are assuming not just today but till the time it matures. Different derivative products involve different levels of risk with credit derivatives considered the most risky. Derivatives are like electricity risky to use but with great potential. Orange county affair was not just a matter of the lack of internal controls but also a lack of internal discipline.
One can come up with rules but people should obey them. Orange 8 Works Cited. Financial Risk Management http://www. riskglossary. com/link/risk_management. htm Introduction to Derivative Financial Instruments by Dimitris N Chorafas Liabilities, liquidity, and cash management By Dimitris N. Chorafas Merton Miller on derivatives By Merton H. Miller Public Budgeting Systems By Robert D. Lee, Ronald W. Johnson, Philip G. Joyce The Orange County Financial Crisis: Risk and Excessive Returns – Wentworth, Hauser and Violich http://www. insiderradio. com/global/e-corp1. html When government fails By Mark Baldassare, Public Policy Institute of California