The Chinese Pension System
February 12, 2025
Alibaba is a Chinese online retail company. This company started as an Amazon wannabe in the Chinese economy. However, today it would be fair to say that Alibaba is equivalent to, if not bigger than its American counterpart. Alibaba’s rise to economic power is filled with many stories. One of them is the story of […]
In the previous article, we have already seen how pension funds have been adversely affected by an increasing amount of longevity risk. The increase in the average lifespan of people is definitely a positive development. However, it has an adverse impact on the financial situation of most pension funds. In order to mitigate longevity risks, […]
In the previous few articles, we have already learned about how venture capital and venture debt work. We now also know the pros and cons of venture debt. However, there is another form of debt called venture leasing which is commonly used by investors in the marketplace. In this article, we will have a closer […]
Retail companies have traditionally been one of the largest users of real estate in the world. It is common for retail companies to lease out large commercial retail spaces and utilize them in their business. Over the years, the usage of real estate has drastically come down because of the increase in online retailing. However, […]
Opportunity cost of a capital is a term unique to economics and finance. It is unique in the sense that you will not find mention of opportunity cost of capital in the accounting books. It is not an explicit cost which is paid out of the pocket. Hence, there is no mention of this cost […]
Pension funds across the world are meant to be low-risk financial instruments. They are allowed to take slightly more risks in some parts of the world as compared to others. However, for the most part, pension fund across the world is advised to stay away from risky instruments such as derivatives.
Derivatives have been known for playing a pivotal role in many market crashes. Hence, pension funds have been traditionally asked to stay away from derivatives. However, that has changed in the recent past. Pension funds are now allowed to have limited exposure to derivatives in most parts of the world.
In this article, we will have a closer look at how pension funds use derivatives to manage their portfolios in a better manner.
In most parts of the world, pension funds use derivatives in a restricted manner. The common restrictions which are levied on the use of derivatives have been explained below.
For example, if the pension funds have some investments in foreign currency, they would end up being exposed to foreign exchange fluctuations. In such cases, they can use derivatives to hedge their foreign exchange risk.
Pension funds have adopted the use of derivatives on a large scale. This is because the use of derivatives provides a lot of advantages. Some of these advantages have been listed below:
For example, sometimes pension funds are able to find investments denominated in foreign currency which provide higher returns. In such cases, they get exposed to forex risks. Hence, they are unable to buy these assets.
However, the pension funds can purchase the investment and nullify the forex risk with the help of a derivative. This will help them to lock in a better return. This is the case with many other investment opportunities. For instance, sometimes the fund may hold floating-rate bonds. In such cases, they can use derivatives to swap their cash flow for a fixed rate of interest.
The bottom line is that derivatives have some utility for pension funds. Even though pension funds cannot use them in an uninhibited manner like hedge funds, they can and must find a way to include derivatives as a risk management tool in their overall strategy.
Your email address will not be published. Required fields are marked *