Question

a.What are the market conditions leading to financial innovation?

b.List several products of financial innovation and explain which market condition led to those products.

Answer 1

Answer1-
The dynamic and challenging market conditions ,which can change within a blink of an eye , also is accompanied by ample opportunities and scope for improvements in the financial system with leads to financial innovations.
New circumstances gets tagged along with newer risks as well as new ideas , triggering new demands by the investors. Hence, financial innovations can be seen as an inevitable part of the financial system.

Answer 2-
Recent financial innovations include hedge funds, exchange-traded funds, multi-family offices, Islamic bonds ,private equity, retail-structured products, including mortgage-backed securities products and collateralized debt obligations .

The different reasons can be listed as follows:
a) Expansion of financial markets: This happens when the markets requires investors to be aware of prevailing risks, and in turn hedge some by using some new products. Which can be attributed for the development of interest rate swaps, CDS etc.
b) Mathematical innovation like BSM, Copula technique, flash trading etc led to the development of options, CDOs, ETFs .
c) Avoiding taxes and liabilities led to the introduction of total return swaps .
d) Improvements in computer and technology led to the improvement in finance also, like MBS, ABS, etc which arrle hugely appreciated as it reduces transactions costs.

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