Derivatives have come under scrutiny in recent times, owing to the use of hedging instruments by companies for financial mismanagement. The misuse of derivatives has put many companies in the legal line of fire. The popular notion that derivatives caused the downfall of companies like Enron, is however, not true. The derivatives by themselves are not damaging. It is their misuse that can cause trouble for businesses.
What are Derivatives? Derivatives are financial arrangements by which your company earns profits based on the functioning of an underlying asset.
If used properly, derivatives can store up your company's defense against many economic problems.
Advantages of Derivatives 1. Flexibility Derivatives can be used with respect to commodity price, interest, exchange rates, and equity price. They can be used in many ways.
2. Risk Reduction Derivatives can protect your business from huge losses. In fact, derivatives allow you to cut down on non-essential risks.
3. Stable Economy Derivatives have a stabilizing effect on the economy by reducing the number of businesses that go under due to volatile market forces.
Disadvantages of Derivatives
If derivatives are misused, they can boomerang on the company.
1. Credit Risk While derivatives cut down on the risks caused by a fluctuating market, they increase credit risk. Even after minimizing the credit risk through collaterals, you still face some risk from credit protection agencies.
2. Crimes Derivatives have a high potential for misuse. They have been the caused the downfall of many companies that used trade malpractices and fraud.
3. Interest Rates Wrong forecasts can result in losses amounting to millions of dollars for large companies. They can wipe out small businesses. You need to accurately forecast the long term and short term interest rates. This is something that many businesses cannot do.
Minimizing Risks with Derivatives
So how do you minimize the above-mentioned risks with derivatives? Here are some suggestions.
1. Future Exchanges Arrange the derivatives through future exchanges. You may need to put in a lot of work here. You must keep track of all adjustments in the market worth of the underlying asset.
2. Asset and Liability Driven Transactions The transactions should be driven by asset and liability management. You should not speculate based on future forecasts.
3. Derivative Policy A good derivative policy focuses more on cost management and less on forecasting. It should aim for cutting down expenses and costs.
Additional Help While dabbling in derivatives is risky if you choose to speculate, derivatives can be an important tool for financial structuring and cost management if you use them correctly. If you do not know how to start investing in derivatives, you can consult a small business advisor or financial consultant. Remember, if you do go for derivatives, always play by the book and never try anything illegal.
Some of the greatest returns on real estate investments are earned by purchasing foreclosed or distressed properties. By investing money in foreclosed properties, savvy real estate investors have learned that they can purchase real estate property significantly under value. You can too if you do your research and avoid common pitfalls.
With every type of investment, there is risk. In most cases the higher amount of risk that you are willing to take results in larger returns on your investment. The same is true in real estate investing. This means that the properties that stand to make you the most money also present the most challenges.
While there are three stages of the foreclosure process where it is possible to purchase the distressed property, only one offers the greatest return. This is the Sheriffs sale or auction phase. If you are able to purchase a property at this time you could realistically take ownership of the property for as much as 45 percent under the listing price of the home. But with this reward comes great risk.
The greatest way to minimize risk when investing in real estate is to do your homework. Heres a checklist to help you out:
Find out how much of a cash deposit you will need at auction. In many cases this is 10 percent with the remaining balance due within months, weeks, days, or hours. Make sure that you know the laws in your state and county.
Try your best to inspect the property before the auction. If you can not inspect the property, strive to build up a relationship with the homeowner so that you can learn about any costly repairs that need to be done and calculate them into your bid price. Verify that there are no other liens on the property through a title search. If you purchase the property at auction, these will become your responsibility.
Know your competition. Since the original lender for the property wins at auction 80 percent of the time, forming a relationship with the lender is a good idea.
Set a bid price and stick with it. Avoid becoming emotionally involved in the bidding process and over bidding. Have a solid idea of what you are investing in, how much you are willing to pay for it, and what type of return you expect.
Remember; the goal of investing is to minimize risk and maximize profit. By doing your homework before the auction, you will be sure to do both. Never buy a property blindly. Doing so only sets you up for failures that will cut into your profit margin.
Both David Gass & James Klobasa are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
David Gass has sinced written about articles on various topics from Accounting Guide, Finances and Network Marketing. David Gass is President of Business Credit Services, Inc. His company publishes a free weekly e-newsletter on Small Business Consulting at their