Question

Abstract of a research paper of using derivitives

Answer 1

Lets start with review of research on financial derivatives, with an emphasis on and comprehensive coverage of research published in 15 top accounting journals from 1996-2017. We begin with some brief institutional details about derivatives and then summarize studies explaining when and why firms use derivatives.

Then discuss the evolution of the accounting rules related to derivatives (and associated disclosure requirements) and studies that examine changes in these requirements over the years. Next, we review the literature that examines the consequences of firms’ derivative use to various capital market participants (i.e., managers, analysts, investors, boards of directors, etc.), with an emphasis on the role that the accounting and disclosure rules play in such consequences.

Finally, we discuss the importance of industry affiliation on firms’ derivative use and the role that industry affiliation plays in derivatives research. Overall, our review suggests that, perhaps due to their inherent complexity and data limitations, derivatives are relatively understudied in accounting, and we highlight several areas where future research is needed.

Use of Derivatives :

•Risk allocation, transfer, and management: Risk gets transferred to someone who is willing and has the ability toassume it which leads to efficient risk allocation.Derivatives allow investors to hedge away risks without trading the underlying itself.

•Information discovery & Price Discovery :Movement in the derivative indicates the direction of the underlying. Being cheaper to trade derivatives price in information quicker compared to the underlying. Also Option market prices are used to infer implied volatility, which can be used to measure the risk of the underlying.

•Operational advantages : Lower transaction costs, More Liquidity, Easier short selling, Increased Leverage ( adv n disadvboth).

•Market Efficiency: In case of presence of mispricing derivatives offer a less costly way of taking advantage of the same. Various types of risks can be hedged by derivatives which increases the willingness of market participants to trade and improves liquidity in the market.

•Criticisms Due to Misuse : High leverage leads to speculative trading that increases systematic risk and destabilization in the markets. Speculative trading is a “zero sum game” benefiting only a limited number of market participants.