Meaning of DERIVATIVES then and now...

13 years back, I was introduced to Calculus. 'Calculus' stands for the 'study of change'. As the term suggests it finds all of its use in Applied Sciences. That makes me confess, given a chance, I would like to re-learn my Physics lessons for the sole reason that the applied part of such topics was never delivered in the right way and like most other science students I developed the theoretical fascination for limits, derivatives and integrals without getting too much into their practical applications.

After graduating and entering into the world of application software development, I had never thought that I will come across these words again.

However, 6 months back I was introduced to DERIVATIVES one more time, albeit in a different context. But this time it was all practical, all real and thus more fascinating.

It’s amazing to know how the use of derivative instruments (derivatives) have revolutionalised the world of finance. Often very famous personalities or much talked about topics/controversies evoke extreme reactions from people. In 2002, Warren Buffet, in the Berkshire Hathaway annual report, termed derivatives as time bombs. He went on saying that these are 'financial weapons of mass destruction'.

On the other hand, Alan Greenspan, then Chairman of the Federal Reserve Bank of New York termed the expansion of financial derivatives as the most extraordinary development of the decade. He was certain of the economic value that these instruments provided to their users.

The views expressed by both the extraordinary visionaries have been proved correct. All derivatives are not equally destructive but there have been several derivative disaster stories. At the same time, the derivative market has grown at breakneck speed and several exotic instruments have made their way to the market.

3 days back I came across Hindalco’s annual results. The company has posted a net gain of 711%. Such mind-boggling numbers were due to the profits from currency derivatives.

It is this lure of large gain that some treasurers succumb to and which helps in maintaining the destructive property of these fascinating instruments. Most of the disasters take place because derivatives find their way as speculative instruments questioning the prudence of the risk management policy of firms.

However, the world of finance would never have been the same without them.