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Derivatives, speculation and hedging

John Hermann

A number of recent articles by Ellen Brown have drawn attention to possible threats posed to financial stability and to depositor’s accounts by the global mega-glut of financial derivatives. See, for example, her article in the previous issue of ERA Review – Winner takes all.

A useful well-referenced article about derivatives may be obtained from Wikipedia under the title Derivative (finance). It is mentioned in this article that the Economist magazine has reported a notional value of over-the-counter derivatives of about $700 trillion. “Hedging” occurs when the buyer of an asset subsequently sells it using a futures contract. This allows the buyer the benefit of holding the asset, while reducing the risk that the future selling price will deviate unexpectedly from the market’s current assessment of the asset’s future value.

According to this article, the proportion of derivatives used for pure (unhedged) speculation is unknown, but it appears to be relatively small. Nevertheless, the money tied up in unhedged derivative activity runs into many trillions of dollars.

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