The Chinese Pension System
February 12, 2025
In the previous few articles, we have come across the various types of risk which are present in an infrastructure project. We have discussed the risk of cost overruns as well as the risks of revenue delays and everything in between. However, all the risks we discussed were directly applicable to the infrastructure company or […]
The costs of issuing an initial public offer can be prohibitive. There are many companies across the world that want to access finances from the general public but cannot do so because they find the costs prohibitive. Hence, in order to bypass the floatation costs, these companies decide to go public without taking the help […]
The Indian banking sector has seen a sudden increase in the number of bad loans. Several of these bad loans were taken by high profile corporate bigwigs, many of whom have exited the country. High profile businessmen such as Vijay Mallya and Nirav Modi have left the country leaving many banks with big holes in […]
The sporting industry has undergone a lot of changes in the recent past. These changes have been related to various aspects of the sporting industry. However, technology has been the driving factor behind most of these changes. Technology has completely transformed the sporting industry and the impact of this transformation has also been felt in […]
Our monetary system has undergone a sea of change in the past century. If our great grandfathers were to see our lives today, they would not be able to relate to any form of payment. Fiat currency, plastic money, negotiable instruments are all creations of the financial innovation that has taken the world by storm […]
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 *