Risk Management Methods:
Derivatives, structured notes, and other complex financial in-
struments fulfil important functions in the financial market-
place. Used properly, these products can effectively reduce risks
and provide stability. When used responsibly, derivatives can
also be used to increase investment returns.
Senator Alfonse M. D'Amato (1995, 1)
As discussed in the previous chapters, the proliferation of financial risks that followed globalization has fuelled financial reengineering, the development of financial derivatives, products that allow banks and investors in general to hedge financial risks; that is, shift them to third parties.
The development of interest rate derivatives, such as Forward Rate Agreements (FRAs), Interest Rate Futures (IRFs), interest rate futures options, interest rate caps, floors and collars, and interest rate swaps, allow banks to shift interest rate risks to third parties. The development of foreign currency derivatives, such as Forward Exchange Rate Contracts (FERC), foreign currency futures and options, and foreign currency swaps allow banks to hedge