All commodity derivatives have tangible underlying asset and physical settlement at maturity. Unlike commodity derivatives, financial derivatives such as stock indexes and interest rate derivatives have financial assets as underlying and are cash settled at maturity.

Generally, what the Financial Engineers/Quants call "financial derivative market"is an assemblage of the relation between demand and supply of the derivative instruments and its mechanism. For example, the anticipated derivative exchange platform that shall be provided by Borse Africa.

With the invention of derivative instruments and the establishment of the derivatives market, the market system in many countries and regions have been promoted much so far especially in providing the instruments and mechanism of risk-shifting because of the characteristics and unique advantages of the derivative market that include flexibility, risk reduction, and stabilizing economy.

Establishing financial derivative market is the objective requirement of market participators' eluding risk and risk venture. The market participators are hedgers-those investors that get into the derivative market to manage or reduce their portfolio's risk exposure, speculators-those who are willing to take the risk shifted from the hedgers and make some riskless profits based on their expectations of the market outcome, without necessarily taking any position in the market, and arbitrageurs-market players whose objective is to take advantage of the price anomalies on the underlying asset and reap some profits across different markets.

Because of the increasing financial risk, hedging is now becoming more and more market participators' choice when they make some investments or trades. However, as explained above, no speculations, no hedges. These two complement each other. The market needs hedgers who want to shift risk to others and the speculators who want to take the risk and make some profits. Derivatives innately own the characteristics of risk-shifting such as options, financial forward contracts and financial futures contracts. A market platform in the nature of Borse Africa with such instruments will provide participators with a proper mechanism of eluding risks and venture. Setting up this platform will meet the objective rules of market development.

In addition, establishing financial derivative market is the objective requirement of the development of the financial market. For some years, investors have realised that the traditional instruments have little room for expanding, and in their quest to maximize their returns and bit the market, they found that some new instruments must be introduced to the traditional factors, thus derivatives are created.

Although our financial market is in very primary stage-not perfect enough, with regards to poor liquidity and irrational prices of the underlying instruments-the demand for the variety and structure innovations of instruments will rapidly increase with our links with the regional and international market as Borse Africa pointed out that Gaborone shall be its financial and technology hub. In this situation, establishing the derivative market filled with innovation mechanism will meet the natural rule of financial market development.

Furthermore, the establishment of the financial derivative market will improve commercial banks' profit-making ability. The derivatives' character of its virtual and levering action will help commercial banks make high profit through great deal of trades with little venture, and gain commissions and fees with their superiorities in the information, technologies and services. That will be an important way of improving commercial banks' profit-making ability.

Establishing the financial derivative market will strengthen the effect of monetary policies and the adjustments of the macro-economy. Our economy has been going through some inflations and deflations in the previous periods. These situations, to some extent, reflect that the central banks' monetary policies are not effective enough; hence we shall face this difficulty for some time. However establishing the derivative market will strengthen the monetary policies effect by providing the central bank with ample and effective information through scientific pricing mechanism, enough operation instruments and rational expectations about the market. The abundance of derivative variety can effectively improve the conductive accuracy of the monetary policies, just like the theory says, "the more abundant the financial instruments are, the more effective the monetary policies play".

In addition, the establishment of the financial derivative market will help us rationally and effectively absorb foreign capital. The abundant variety of derivativeinstruments will provide some foreign investors with more choices of ways of entering and withdrawal to improve the liquidity and profit. This will help much foreign capital float into our country.

However, having said all that, it should be noted that derivatives have come under general 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 and pushed them to the edge of financial distress. The derivatives by themselves are not damaging, but their misuse can cause trouble for the companies. As Warren Buffet once said, they are the "Financial weapons of mass destruction".

For example, in 2005 the China Aviation Oil (CAO) a Singapore subsidiary company reported derivatives-induced losses close to US$50 million. The losses were due to positions CAO took in the option contracts on oil futures. The then CEO was sentenced to a four year jail term after being convicted. Basically, if misused, derivatives can boomerang on a company and its subjects.

Some blame them for the global financial system debacle that sent the whole world into recession, with the fingers pointed at the Financial Engineers/Quants.

Thus, given their level of benefits, the critical shortcomings shouldn't be ignored as they serve as the heads-up. The blue print of the regulatory framework should accommodate such mishaps as they are bound to transpire. They say, "for warned is for armed".

Ikanyeng Prigar Segonetso
Bachelor of Financial Engineering (Hons)
Multimedia University Cyberjaya
concerned_4life1@hotmail.com