Understanding Tax Terminology: Tax Rates
In the previous article, we discussed about how tax base calculations work. However, tax base calculations are just one part of the story. The other part of the calculation is the tax rate. Tax base and tax rate are multiplied to arrive at the tax amount owed by the organization. In this article, we will […]
Public-Private Partnership in Stadium Financing
In the previous articles, we have already seen that funding a stadium can be very difficult from a financial point of view. The financial aspects of stadium financing can be challenging regardless of whether the financing will be provided by the government or by private parties. It is important to note that stadium financing can […]
Why Government Should Not Invest Public Money in Sports Stadiums Used by Professional Franchises
In the previous article, we have already come across some of the reasons why the government should not encourage funding of stadiums that are to be used by private franchises. We have already seen that the entire mechanism of government funding ends up being a regressive tax on the citizens of a particular city who […]
Deutsche Bank: The Fall of a Giant
The European banking system has been in a bit of a crisis in the last few years. Major European banks have not recovered from the low valuations that they received during the 2008-09 banking crisis in the United States. American banks seem to have recovered from the shock and are close to their previous valuations. […]
The Quasi-Government Sector
In most parts of the world, the financial system can be divided into two parts viz. the private sector and the government sector. However, in many parts of the world, there is a third sector called the quasi-government sector. This sector has the characteristics of both the government as well as the private sector. The […]
Derivatives may have found their way into the media in very recent times. However, they have been used by mankind for a very long time. Since the inception of time, humans have not liked the idea of uncertainty. More so, they did not like the idea of economic uncertainty. Hence, the need to offset this uncertainty gave rise to the evolution of contracts. Earlier contracts were verbal agreements and were not as sophisticated as the ones today. However, they were contracts nonetheless. In this article, we will trace the evolution of derivatives throughout the ages.
Derivatives are said to have existed even in cultures as ancient as Mesopotamia. It was said that the king had passed a decree that if there was insufficient rain and therefore insufficient crop, the lenders would have to forego their debts to the farmers. They would simply have to write it off. Thus, the farmers had just been given a put option by the king. If certain events unfolded in a certain way they had the right to simply walk out of their liabilities!
There have been many such examples that have been quoted during the time. Another famous example pertains to Greek civilization when one of Aristotle’s followers who was adept at studying meteorology predicted that there would be a bumper crop of olives that year. He was so sure that he went ahead and purchased the produce of all the Olive farms in and around Athens before the crop had been harvested. In the end it did turn out to be a bumper crop and Aristotle’s disciple made a huge profit from his way ahead of time forwards contract.
19th Century: Chicago Board Of Trade
During the nineteenth century, America was at its pinnacle of economic progress. America was the center of innovation. One such innovation came in the field of exchange traded derivatives when farmers realized that finding buyers for the commodities had become a problem. They created a joint market called the “Chicago Board of Trade”. A few years later, this market evolved into the first ever derivatives market. Instead of buyers and sellers negotiating their own customized contracts, there were now standard contracts listed on the exchange which could be bought and sold by anyone. This idea proved to be a big hit. Soon Chicago Board of Trade had to create a spinoff called Chicago Mercantile Exchange to handle the growing business.
Recently Chicago Board of Trade and Chicago Mercantile Exchange have been merged to form the CME group. It is still one of the foremost derivatives markets in the world. The massive success witnessed by the members of the Chicago Board of Trade led to the creation of many such exchanges across the globe. However, during the era of Chicago Board of Trade, derivatives trading was limited to commodities only. Other financial instruments were largely outside the realm of such trading.
Innovations in the modern financial market have largely been based on the idea of derivatives. What started as a simple idea in ancient times was later developed into standard contracts during the Chicago Board of Trade era has now become a maze of complex financial instruments and contracts. The asset classes on which the derivative instruments were based have undergone a rapid expansion. Nowadays, there is a derivative for pretty much everything.
We have derivatives for stocks, indices, commodities, real estate etc. We even have derivatives that are based on other derivatives creating a Meta structure of sorts. The reason behind this rapid expansion is that derivatives meet the needs of a large number of individuals and businesses worldwide.
After the collapse of 2008, derivatives had to take the fall for the entire chain of events. They were vilified by the media in general. That has come as somewhat of a setback. Barring that the rise of derivatives in the recent years has been nothing short of extraordinary and this is expected to continue in the future.
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