Some random musings on derivatives PSU SBA brownbag presentation May 14, 2010

A bit on my background Petroleum products purchasing in early 1990s. – Jet fuel in airline industry – Diesel fuel for wholesaler Designed “fixed-price” diesel fuel program for fuel wholesaler in Managed company’s fuel price risk by trading in crude oil and heating oil futures and options. Academic career: research on corporate hedging since 1995.

Some general overview Derivative – Major types of derivatives Forward contracts Swap contracts Futures contracts Option contracts – Trading environment Exchanges – Clearinghouse bears credit risk Over-the-counter (OTC) – Historically, each counterparty bears the credit risk of other counterparty.

Where do contracts trade? Forwards → OTC Swaps → OTC Futures → Exchanges Options → Both

What types of “underlying assets” trade in derivative markets? YOU NAME IT! – Currencies – Interest-rate – Commodities – Credit – Equity – Arcane contracts (weather, carbon, etc.)

Current Issues Do derivatives pose “systemic risk” to economies? – Basis for AIG bailout → counterparty in many credit default swaps (more on this idea later) Derivatives markets will ultimately be more regulated. Should all derivatives be cleared through central clearinghouse?