Date of Completion

Spring 4-28-2014

Thesis Advisor(s)

Patrick Terrion

Honors Major

Finance

Disciplines

Finance and Financial Management

Abstract

Derivatives were created as a method of hedging risks. Yet in today's society, derivatives have taken on many new roles, and with it have systemically changed the way the financial industry operates. Warren Buffett called these powerful tools "financial weapons of mass destruction." No longer do these tools simply mitigate risks; instead, they are creating new and potentially lethal risks. How did their usage shift from risk management? This thesis delves into what actions occurred over the past half century that drove derivatives usage to what is facing the market today. Through the exploration of major successes and failures of derivatives, such as Long Term Capital Management, Paulson & Co., the financial crisis, and Enron, the new uses of derivatives are extrapolated. Today's companies, both in and out of the financial services industry, are using derivatives for hedging, speculation, and arbitrage. This shift is deduced as a method of supplementing regular business activities. All companies and executives are attempting to find ways to expand profits, and many are turning to derivatives. These instruments have also infiltrated all corners of the market, having a stranglehold in hedge funds and ETFs. Today, the notional value of all derivatives signficant exceeds the the size of the world's economy. The new forms of usage of derivatives now poses a significant threat of the modern financial world.

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