In General Terms Explain Why Certain Types of Derivatives Such

question 17

Essay

In general terms explain why certain types of derivatives such as options,futures,swaps,and other exotic contracts can generate such catastrophically large losses and even insolvency for users at times. Does this mean that corporate or institutional use of derivatives should be limited or otherwise regulated? Explain.

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Definitions:

Modified Duration

A measure that quantifies the sensitivity of the price of a bond or other debt instrument to changes in interest rates, indicating the percentage change in price for a parallel shift in yield curves.

Corporate Bond

A type of debt security issued by corporations to raise capital, promising to pay back the face value plus interest.

Coupon Rate

The interest rate stipulated on a bond’s certificate, paid to its holder at specified intervals until maturity.

Yield To Maturity

The total return anticipated on a bond if it is held until the end of its lifetime, accounting for interest payments and price changes.