ntial interest payments, and even indexes such as the Standard & Poors, or the Dow Jones Industrial Average (Ayling, 1986). McClintock (1996) explains how derivatives can be sold and traded on regulated exchanges, such as the Chicago Board of Trade, although most of them are created directly between counter parties, referred to in the literature, typically, as "Over The Counter." He points out that the primary purpose of derivatives is to reduce the risk inherent in fluctuations of foreign exchange rates, interest rates, and market prices. Derivatives traded on exchanges also are said to serve as a "price discovery mechanism. According to the Bank for International Settlements' October 1992 report, Recent Developments in International Interbank Relations, swaps are the largest type of derivatives, as measured by the notional principal amount outstanding" (McClintock, 1996, 15).
That concept of the "principal amount outstanding" summarizes the main problem with derivatives (Adler & Prasad, 1992). Since they are entirely "futures-based" the derivative shares a double risk; that of the future growth (or diminution) of the assets and that of the derivative asset based on those assets. In normal accounting processes, a derivative can be used to maximize risk sharing, letting the company efficiently allocates capital for productive and safe investment opportunities (Merton, 1995, 32).
Geer (1997) observes that in 1997, companies and banks around the world had some 60 trillion dollars (US) worth of financial derivatives (Geer, 1997, 52). Companies such as Coca-Cola, Microsoft, Disney, Virgin Atlantic and General Motors use financial derivatives as a standard part of their value-added accounting process (Amihud & Mendelsohn, 1986, 237). When derivatives fail, we usually only hear about them if the parties end up in court, as is the case of Procter & Gamble versus Banker's Trust. The depositions filed show that the cause of actio...