The dark side of derivatives is well known: Speculation and excessive risk can yield staggering losses. But not so well understood are the proper ways to use derivatives. Sell-side firms, such as financial institutions that sell derivatives to buy-side clients, identify a need and tailor a solution that is aligned with a client’s interest. That is the proper way to create a derivatives hedge, Bruno Dupire, Bloomberg’s Head of Quantitative Research, told delegates at 66th CFA Institute Annual Conference in Singapore. In his talk, Dupire provided much-needed guidance on how to extract value and avoid pain from the intricacies of the derivatives market.
“Good derivatives products represent an economic exchange that should benefit both parties and address economic exposures while optimally redistributing the risk between buyer and seller,” he said. That ideal, of course, was something that was all too infrequent during much of the pre-crisis derivatives trading.