A swap agreement constitutes an agreement between parties for swapping different payment flows over specific periods (Cherotichet al., 2015; Crouhyet al., 2001). Whilst different types of swap agreements exist, the most common are currency swap and interest rate agreements (Cherotichet al., 2015; Crouhyet al., 2001). It is important to keep in mind that trading in derivatives also frequently takes place outside the regulated market for security and financial establishments have to mandatorily inform investors when this takes place (Zhao et al., 2009; Dai et al., 2007). Investment in derivatives outside the regulated market can lead to investor risks because they may not be able to settle agreements for open derivatives, because of the absence of a market for the same (Zhao et al., 2009; Dai et al., 2007).
3.3.5. Mortgage Backed Securities
A mortgage backed security constitutes a type of an asset backed security that is essentially secured either by a mortgage or a group or collection of mortgages (Norden et al., 2014; Crouhyet al., 2008). Such a security may also be grouped in a rating as specified by an accredited credit rating agency and involves periodic payments (Norden et al., 2014; Crouhyet al., 2008). Such a security is very frequently used for the redirection of principal and interest payments from the pool of mortgages to shareholders (Norden et al., 2014; Crouhyet al., 2008). Investors buy mortgage backed securities because they provide attractive rates of return. Other advantages include liquidity, efficiency and transfer of risk. These securities are however associated with some risks (Dai et al., 2007; Arnaboldi&Rossignoli, 2015). Borrowers can prepay mortgages, which can create risks in falling rate environments as they could refinance their mortgages at cheaper rates (Dai et al., 2007; Arnaboldi&Rossignoli, 2015). As they can be refinanced, they also have call risk.
3.4. The Role and Utility of Innovative Financial Instruments in the Global Economy
Cherotichet al., (2015) stated that financial instruments constituted legal agreements that called upon one party to pay money or other consideration of value or commit for payment in accordance with clearly laid down conditions to counterparties in exchange for indemnification against various risks, interest payments, premiums and acquisition of rights. The counterparty, in exchange for such payment hoped to benefit through premiums, the achievement of capital gains, and the receipt of interest or the indemnification of losses (Crouhyet al., 2008; Chavaet al., 2013). Whilst financial instruments can exist in documentary forms like loan contracts or stock certificates, they have increasingly been standardised and are recorded in electronic accounting systems (Crouhyet al., 2008; Chavaet al., 2013). Innovative financial instruments have grown in usage across the world steadily on account of their diverse benefits (Corsiet al., 2016; ForrerAcie&Forrer Donald, 2015). They are utilised by traders for speculation with regard to interest rates, future prices, levels of indices, as well as other financial measures, as also to hedge financial risks (Corsiet al., 2016). Speculators bet on future prices through the prediction of future prices or other financial measures (Corsiet al., 2016; ForrerAcie&Forrer Donald, 2015). Hedgers on the other hand aim to reduce financial risks through the purchase or sale of financial instruments, whose value is likely to vary inversely with the hedged risk (Laevenet al., 2015; Schueffel&Vadana, 2015). As elaborated in the previous section, there are several types of financial instruments, many of which can be tailored by parties for their own requirements (Laevenet al., 2015; Schueffel&Vadana, 2015). Individuals and organisations make use of options and futures for achievement of capital gains or the limitation of risks; currency tradin
