Question

The global financial crisis illustrates that derivatives cannot be used to hedge financial institutions should be barred from using them in any form. True False

Answer 1

Answer:

False

Explanation:

Financial institutions normally use derivatives to hedge a position's risk, by protecting themselves against the risk of an adverse move in the value of an asset. If it is properly used, this practice should reduce risk, not increase it.

The problem that occurred during the financial crisis of 2008 was that financial institutions abused of hedging practices. Too much of anything is never good. During the years that preceded the financial crisis, financial institutions engaged in hedging practices over and over again using the same derivatives, forming a web like structure. It was like building a castle on top of a single stone, but when that stone moved, the whole thing collapsed.