The last twenty years have witnessed several innovations which have made several implications to the financial sector. There are many instruments that have been employed by financial institutions like banks since 1970. Some of the innovations are: butterfly spreads, Eurobonds, program trading, collateralized mortgage bonds among others. These innovations were developed after a stagnation period in the financial industry (between 1903 and 1960s). There are factors that have facilitated this kind of innovation. However, there are also complaints that are associated with this trend of development of innovations. The purpose of this paper is to find out the factors responsible for this trend, its contribution to the well-being of the people and lastly, to explore the likelihood of future innovations.
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The modern financial innovations can be attributed to specific factors which have facilitated the growth of this process. One such factor is the shift towards floating exchange rates, this was one of the move adopted by the United States government in the early 1070s. This was as a result of the fluctuations that resulted from the uncertainty in majority of the international transactions. The Chicago Mercantile Exchange reacted to this uncertainty by developing an exchange-traded foreign exchange. This innovation led to the hosting of subsequent products while the exchange rates spread to the interest rates. These exchanges began the process of development on the same time thus, resulting to the diversification of the traditional agricultural market.
Another contributing factor to the high trends of financial innovations is the application of information evolution to the finance industry. Particularly, the use of electronic computers and information technology boosted the speed of financial transactions in the 1970s. However, computers were invented in the early 1950s but they did not have major impacts until the late 1960s. The design of computers with transistorized circulatory begun in the late 1960. This technology resulted to affordable prices for computers and also made such computers effective in designing products like stock index arbitrage. Computers made transactions faster since the number of transactions in institutions like banks were too high thus requiring quick data processors. Thus, computers played this role since they had quick data processing capacitors; this was not a common technology during the stagnation era.
World economic growth and innovation was a major factor that contributed to the burst on the financial innovations in the 1970s. The stagnation period of the early 1960s was characterised with low economic growth; this implied that the demand for commodities was low. This period was followed by another period (1970) when the world’s economy started to grow rapidly; this lead to the demand for various goods increasing at an alarming rate. As a result of this demand, states had to innovate ways to develop modern financial instruments and suitable markets. Most of these innovations were government sponsored. For instance, the United States introduced instruments the Federal Home Administration loan guarantee and the mortgage schemes. With such instruments, civil servants were in better positions to acquire houses on loans. However, private innovations could have grown but they were interrupted by the Second World War in the early 1940s. The Second World War lead to drained man power and resulted to restrictions being imposed in financial transactions with more emphasis on international transactions.
The regulations and deregulations that were imposed during the period between 1943 and 1940 also resulted to the growth of financial innovations. There were rewards that were given to those people who were able to invent around the obstacles that were erected by the governments. This provided an opportunity to major innovations of that time. For instance, swap; this was an innovation whereby, a corporation was in a position to exchange its fixed rate obligation of borrowing for another floating rate of borrowing.
The innovations in the financial industry can be considered as having improved the lives of people. Free market economists argued that these financial products of the 1970s and the 1980s substantially cut down the cost of undertaking many types of financial transactions. An example of the benefits associated with these innovations was the case of a pension funds for employees which were in a common stock that was well diversified. If the high interests for the beneficiaries were to be achieved, such funds could be transferred from the common market to the treasury bills. This procedure could be undertaken by first selling the stock portfolio company while at the same time incurring the commission and the fees. The collected cash proceeds could be put in the treasury bills again, therefore incurring other transaction costs.
However, there are cases that have been raised against these modern financial innovations. One of the major cases against these modern financial instruments is that they lead to short term trade. This is so because, by lowering the costs of transactions, there is the likelihood of over production of commodities. This trend therefore results to a lot of resources being wasted. These complaints can be avoided through mechanisms such as, stock market volatility. This mechanism can be used to avoid disputes between middlemen and speculators through measuring the amount of stock available using the existing data. Volatility if measured as standard deviation of the returns is slightly higher as compared to the cases during the 1960s. Other methods to avoid the complaints associated with the financial innovation instruments are the use of index products and index arbitrage. These mechanisms help in establishing whether the index futures are responsible for an occurrence or the possible crash.
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As discussed above, the last 20 years have witnessed a wave of innovations that have heavily impacted on the financial sector. There are possibilities that the modern financial instruments will be exported to other countries and which may or may be not effective. There is need for some research to be undertaken to establish whether the next 20 years will witness such a transformation.