3.3. Types of Innovative Financial Instruments and Associated Risks
As elaborated in the earlier section, financial instruments have on account of continuous innovation evolved enormously over the years and can be classified into various types. This section of the dissertation engages in a discussion of the various types of innovative financial instruments and their associated risks. Li et al., (2009) stated that financial instruments involved various types of risks; a number of risk factors however apply to all types of financial instruments. These are detailed below.
Market Risk: Market risks evolve from the fact that alteration in market prices can have adverse consequences for financial instruments (Kolb &Overdahl, 2009; Norden et al., 2014).
Interest Rate Risk: This risk stems from the fact that alterations in interest rate can have adverse consequences for the value of financial instruments (Crouhyet al., 2008).
Currency Risk: Exchange rates generally fluctuate from time to time. Financial instruments that are registered in foreign currencies are subject to currency risks. Alterations in currency rates can result in profits or losses, even though the currency value, wherein the underlying financial instrument is registered is not subject to alteration (Kolb &Overdahl, 2009; Norden et al., 2014).
Liquidity Risk: Such a risk may stem from the fact that the holder of an instrument may not be able to purchase or sell a particular financial instrument at a specific point of time or may be able to do so only on terms that are significantly lower than the standard in an active market in general. Such liquidity risks can be generated by diverse factors, like for example market inactivity with regard to a specific instrument, size of contract and diverse other factors that may impact demand and supply, as well as the behaviour of market participants (Corsiet al., 2016).
Economic Risk: There is little doubt that economic alterations and fluctuations, especially economic booms and slumps can impact the prices of financial instruments. These fluctuations can vary in different ways with regard to both magnitude and time and can impact diverse industries in different ways (Crouhyet al., 2001; Cherotichet al., 2015).
Country Risk: This risk stems from various environmental issues like political risks, economic risks, risks connected to capital transfers and currency risks. The risk is connected to various economic factors that could significantly affect the larger business environment in which the registration of the financial instrument has taken place (Corsiet al., 2016; ForrerAcie&Forrer Donald, 2015).
Legal Risk: This risk stems from the changes made by governments to existing laws and regulations like for example alterations in taxation laws or inter border capital transfer laws, which can have an adverse impact on the value of financial instruments (ForrerAcie&Forrer Donald, 2015).
Inflation Risk: This risks stems from the likely impact of inflation on the valuation of a financial instrument (Crouhyet al., 2001).
Counterparty Risk: This risk stems from the possibility that a counterparty may not be able to satisfy its contractual obligations completely (Cherotichet al., 2015).
Settlement Risk: This risk is connected with the possibility of a counterparty not being able to satisfy contractual obligations on the date of settlement. Losses in settlement can take place on account of default or even on account of differences in timings of settlement between relevant parties (Altman et al., 2005).
3.3.1. Shares
Shares are issued by corporations or limited firms to shareholders as proof of their ownership interest in specific companies (Turnbull, 2010; Domeheret al., 2015). Such shares are issued either electronically in a securities depository or as written instruments (Turnbull, 2010; Domeheret al., 2015). Shareholders can trade their shares in the market and are entitled to the rights that are provided by law, as well as the arti
