CHAPTER 6Derivatives: Financial Weapons of Mass Destruction

“We view them as time bombs for the parties that deal in them and the economic system. In our view, derivatives are financial weapons of mass destruction (WMD), carrying dangers that, while now latent, are potentially lethal” (Warren Buffett, Berkshire Hathaway’s 2002 annual report).

As the Buffett indictment indicates, few areas of finance are more controversial than derivatives. Because derivatives are central to the strategy of (many) hedge funds, hedge funds have been placed at the center of this controversy. However, as with many things in finance, the risks and benefits of derivatives depend on the context and usage. In the right hands and the right reasons, they can be tremendously ...

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