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Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: TobagoJack who wrote (53801)	9/29/2004 1:08:39 PM
From: elmatador	Read Replies (1) \| Respond to of 74559

Use of currency derivatives rockets By Jennifer Hughes in New York Published: September 28 2004 18:13 \| Last updated: September 28 2004 18:13 Suspicious investors may make derisive comments about derivatives, but the latest data show explosive growth in their use in the currency markets. Daily trading in over-the-counter currency options, forward rate agreements and interest rate swaps is worth $1,200bn a day, according to the Bank for International Settlements, which released its triennial survey of the foreign exchange markets on Tuesday. In 2001, trading had totalled $575bn, or $690bn at 2004 exchange rates. While the timing of the survey, taken in April, may have boosted the use of interest rate-related products because of a sharp shift in expectations for US rates during that month, observers said the growth in the use of derivatives came as little surprise to those in the market. Options are often regarded with suspicion and they are often known for their involvement in banking scandals such as the A$360m loss suffered by National Australia Bank this year, and the $700m losses at AllFirst, a US subsidiary of Allied Irish, in 2002. Warren Buffett, the legendary US investor, memorably referred to them as “financial weapons of mass destruction.” But the massive growth suggests currency investors at least, are less worried. “There is the opportunity for the less knowledgeable to take on perhaps more risk than they're comfortable with, but to say derivatives are inherently risky is a little bit false,” said Simon Derrick, head of currency strategy at Bank of New York. “The whole point is to allow you to raise or reduce your risk as you like.” The ballooning of their use in the currency markets was matched by overall volume growth, according to the BIS. Traditional FX trading volumes - made up of the spot market, forwards and swaps - rose 36 per cent to a record $1,900bn in 2004, from $1,200bn in 2001, or $1,400bn equivalent at 2004 exchange rates. See more on BIS report Market observers said the growth in both options and traditional FX was largely the result of greater interest from active fund managers, particularly hedge funds. Traders said a lot of former options staff in investment banks had moved to hedge funds and as a result, the sophistication of funds' use of derivatives was growing. Nigel Babbage, global head of FX options trading at BNP Paribas, said he'd noticed increasing sophistication and comfort with derivatives on the part of clients. "The results come as no surprise to us, especially the growing importance within FX of the derivatives universe," he said. "Often clients do not have a view as such on options issues like 'vega' or volatility - they are trying to express directional views through options.” The explosive growth in options, and the mathematics they entail, also reflects a trend less welcome to some of the market's older participants - the rise of the quant, or quantitative analyst, as the traditional use of economic fundamentals in currency products and analysis is squeezed. Quants are now employed by most banks to apply their analysis across an ever-broader range of products. “You probably can't get started as a currency strategist these days without a PhD in engineering, maths or physics,” said one London-based strategist with an MSc in economics. However, one term most market participants are aware of is the “volatility smile,” - the measure of implied volatility for a particular strike price that in textbooks is shaped like a grin. Judging by the figures from the BIS, volatility has given many in the market plenty to smile about. www.ft.com/exchanges2004