Speculative derivatives be prohibited

Full Answer Section

   

• Market Liquidity: Derivatives can increase market liquidity by allowing more participants to engage in transactions. A ban could reduce liquidity and make it more difficult to buy or sell certain assets.
• Innovation: The derivatives market is constantly evolving with new products being developed. A complete ban could stifle innovation and limit the ability to develop new financial tools.

Arguments For Prohibition:

• Financial Crisis Risk: Some argue that excessive speculation with derivatives can contribute to financial system instability and crises. The complexity of these instruments can make it difficult to assess risk, potentially leading to cascading losses.
• Market Manipulation: Concerns exist about the potential for manipulation of derivative markets by large institutions, leading to unfair advantages and distorted prices.
• Limited Economic Value: Critics argue that some derivatives have little underlying economic value and are primarily used for speculation, potentially creating bubbles and distorting economic activity.
• Transparency and Regulation: The lack of transparency in some derivatives markets makes it difficult to regulate them effectively. A ban could force a shift towards more transparent and regulated financial instruments.

Finding a Balance: Instead of a complete ban, a more realistic approach might involve stricter regulations to mitigate the risks associated with derivatives. This could include:

• Position Limits: Setting limits on the amount of a particular derivative a single entity can hold to prevent excessive speculation.
• Margin Requirements: Increasing the amount of capital required to trade derivatives, reducing the potential for leverage and risky bets.
• Increased Transparency: Implementing stricter reporting requirements to improve market transparency and allow regulators to better monitor activity.
• Standardization of Contracts: Standardizing derivative contracts could make them easier to understand and manage, reducing risk and facilitating oversight.

Ultimately, the goal is to create a system that allows businesses to manage risk effectively while preventing excessive speculation and protecting the stability of the financial system. By carefully considering the arguments on both sides and implementing appropriate regulations, policymakers can find a balance that allows derivatives to play a constructive role in the financial system.    

Sample Answer

   

Speculative derivatives are a complex financial instrument with both potential benefits and drawbacks. The question of whether to prohibit them entirely is a controversial one, with strong arguments on both sides. Here's a breakdown of the key points to consider:

Arguments Against Prohibition:

• Risk Management: Businesses use derivatives to hedge against price fluctuations in commodities like oil or currencies. A ban could limit their ability to manage risk and expose them to greater financial instability.
• Price Discovery: Derivatives markets can influence the underlying asset prices through speculation. This price discovery function can improve market efficiency and transparency.