Within the last century or two, finance, risk, and financial markets have taken on a new precedence. Mathematicians, street merchants, and trend makers have introduced new financial instruments that are comparable to the discovery of nuclear physics. Names like currency options, stock options, commodity options, and derivatives have yet to be comprehended fully by the average person. Ironically, these misunderstood financial abstracts are responsible for the real wealth in the world not oil, gold, vehicles, or anything related to the gross domestic product.
Now, imagine opening the paper and you read, “Allied-Lyons loses $270 million”, “Air Product & Chemicals loses $113 million”, and “Metallgesellschaft suffered loses over $1.34 billion”. When asked to elaborate (as these are not operational based losses), all of these companies refuse, and maintain silence. What happened?
One of the best kept secrets of corporate America: some of the biggest name companies are trading with advanced financial instruments. Big names like Ford, Procter & Gamble, and Air Products & Chemicals have been found trading not only for profit, but for financial insurance. According to the paper “Use of Foreign Exchange and Interest Rate Risk Management in Large Firms” by Professor Walter Dolde, 85.2% of Fortune 500 companies use derivative securities. Yes, you heard it right, around 85% of large firms are trading in derivatives. Some sources say General Motors, used currency options to pay the principal on the bond/loans they were granted. I mean, this is going on all around the corporate world. Derivatives and other trading are now as important or more important than marketing, production, and Research and Development segments.
This is not old, but it is definitely not anything new. Corporate entities have always had trading rooms, and financial teams that dealt with the markets. Shareholders have no idea what is going on in due part to the lack of financial accounting laws, and regulations. Usually shareholders are kept in the dark until they learn the business has lost millions (sometimes billions) of dollars in some type of complicated financial trade. On the flip side, companies are also generating millions and billions of unaccounted profit via financial markets. It goes both ways
Why are these companies doing this? They are doing this to minimize risk and capture economic advantages. Its called hedging, which in my eyes, is not your “typical” hard-nosed investing.
Derivatives (remember 85% of large firms are involved in derivatives), like the mathematical function, are none other than financial packages that protect against potential risk.
Lets look at an example: A baking company need to buy wheat in order to produce some of its goods. The company knows that wheat prices fluctuate based on season and other factors. Being financially savvy, a representative from the banking company buys something called a “wheat future”, which allows them to lock in a steady price NO MATTER how the price of wheat fluctuates. It’s that simple!
Do you now see why companies are interested in derivatives like options, futures, and mortgage backed securities? It potentially protects companies from loss, in minimizes risk and costs. Don’t be fooled though, there are obvious downsizes to this, as evidenced by the reported losses.
Is this information important to know? Of course. The world is changing. No longer are “investors” and “traders” using simple financial instruments to boost profits and stay ahead. They are using complex instruments to make profit. The companies are trading for profit! These are billion dollars deals, many of these people are taking home millions of dollars in bonuses. Don’t you think you should understand what’s going on here?
Essentially, if you are an entrepreneur and you are going to be opening up any type of company that deals with commodities, goods, or products, then you can benefit from having someone on the team who can deal with derivatives.
On the flip side, every citizen needs to be aware of what is going on in their perspective country. Its called awareness. If top companies are trading derivatives, if most of the world’s wealth is held in this abstract market, then obviously, one should understand what is going on. There is all kinds of politics behind this phenomena, and some even call it toxic finance, a type of finance that could end the civilized world as we know it, if done incorrectly.
For more information, goto your local library and ask for the section on derivatives, options, and foreign exchange trading. I recommend the book “The Vandals’ Crown: How Rebel Currency Traders Overthrew The World’s Central Banks.”
Remember, we cannot cover a complex subject like derivatives, and its connection to Fortune 500 companies in a single blog post! Our research on the topic is enough to fill a book.