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Derivatives Case Study

In a recent paper, Sjur Westgaard, Stein Frydenberg, Sunil K$.$ Mohanty, $$Fourteen large commodity trading disasters: What happened and what can we learn?," Journal of Commodity Markets, Volume $27,2022$ make the following argument:

$$Problems can arise when commercial agents move away from their hedging strategies and become pure speculators or when other

agents without underlying exposure $($e$.$g$.,$ investment banks, hedge funds, private investors$)$ take far too large a position relative to

their equity. This can lead to large losses and, in some cases, bankruptcy for the agent.$$

Write a report to critically evaluate this statement.

In your report, you should address the following issues:

$$ Discuss the theoretical function of financial markets and derivatives in risk diversification.

$$ Evaluate whether this function always holds true in practice, particularly when considering the complexity and potential misuse of derivatives.

$$ Select at least one historical case where the use of derivatives led to significant losses. Outline the trading strategy that was responsible for these losses. CHOOSE AMARANTH.

$$ Critically assess the extent to which the inherent risks of economic activity were diversified or exacerbated by the financial markets and derivatives in this case.

$$ Discuss the main lessons that the financial industry and market participants should learn from the case$($s$)$ you have examined. Reflect on the implications for risk management practices and the regulation of financial derivatives.

$$ Conclude with a nuanced perspective on the role of financial markets and derivatives in risk diversification, considering both their potential benefits and drawbacks, as highlighted by the case$($s$)$ discussed.