What Stimulated The Popularity Of Financial Derivatives?

The financial market cites the operation of financial derivatives to be a staggering billion dollar industry. A huge portion of the financial sector relies so much on the financial derivative movement. How did this financial strategy become a billion even trillion dollar operation? What is the impetus or stimulus for people to engage in such financial transactions?

Factors that Created the Need for Financial Derivatives:

The need for financial derivatives came out as a result of many factors. There is not a single factor that created the need.

The interplay of these factors made the financial market as big and as important as it is now.

1. Trade and business - Commerce has been a very important impetus for the creation of financial derivatives. People in a certain place do not enjoy all the materials and services that they want or need. Hence, they needed to trade or exchange their products and services in return for another type. However, there are certain risks associated with the involvement on such transactions. Take for example a grape farmer and a wine maker. Both parties need the other in order to succeed in their business ventures. This spurred the creation of contracts. The grape grower can agree to sell his produce to the wine producer at a price that the two parties will agree on. This then assures the grape grower an income and the wine maker a supply of grapes. The simple trade and business movement served as an impetus to create financial derivative contracts and processes.

2. Banking - As business and trade transactions expanded and became more complex, there became a need for a body that will take care of financial records, reports and all business related concerns. This organizing body evolved into the banking systems of today. The rise of banking served to push the popularity of financial systems and all the forms of financial derivatives.

3. Computers - Modernization greatly fuelled the growth of financial derivative operations. The principles of financial derivatives are largely abstract and complex. It consists of operations, monetary values, assets and exchanges that are oftentimes intangible. The management of these intangible data categories has been made easier with the introduction of computers. These instruments of technology also made it easier to make business deals in the fastest and most convenient manner. Computers became an enzyme or catalyst for increasing the use of financial derivatives.

4. Instability of the Financial Market - The financial market is said to be as stable as liquid. This means that the financial market is highly volatile and unpredictable. The use of financial derivatives lessens the impact of the financial market's volatility or instability. Through financial derivatives and the contracts involved, the risks of losses due to financial instability can be greatly reduced.

It is not a single factor that sparked the popularity of financial derivatives. The interplay of these factors made the financial market as big and as important as it is now. These factors all contribute to the birth and development of financial derivatives.