Among the many things financial professionals do for customers, perhaps the most important is to minimize and mitigate risk. The complex financial products that exist, from interest rate swaps to call options to the most complicated synthetic derivatives all have the same ultimately raison d’être: to limit risk of a major event wiping out the wealth of a client.
This is often misunderstood. One of the criticisms of Wall Street is that it is a “casino”; this criticism often focuses squarely on these derivatives, and a reference to Warren Buffett’s famous quote describing derivatives as “weapons of mass destruction” will likely spring up during the argument. But Buffett himself uses derivatives and has made a lot of money doing so. In any case, Buffett’s self-described “best trade” was investing in Geico, an insurance company that essentially sells put options on insurance buyers’ futures.
Of course, we don’t think of insurance that way, but in terms of behavior, mathematics, and purpose, insurance and derivatives are the same thing. Which is why the criticism of them is often misplaced.
And the importance of derivatives and their use to avoid wipeouts from black swans events became intensely clear when the Turkish lira had a hyperbolic decline. Moving over 15% in a single day, the lira was weakening fast against all other currencies and was wiping out the value of companies whose debts were in U.S. dollars (think a Turkish factory that hasn’t settled debts with American distributors) and whose assets were in Turkish lira.
This is what currency swaps and forex products are designed for.
Those companies that employed derivatives and had a currency strategy avoided the sudden collapse in value that other companies in Turkey are suffering.
This is just one way that derivatives are used to lower risk in corporate finance, and it’s an invaluable tool that is used to make modern global trade possible and profitable.