Investors Go for Latin Derivatives To Guard Against Economic Swings

Derivatives traders are trying to make Latin America a safer place to invest.

Trading of derivatives - complex securities used to hedge against losses as well as speculate on price gains - has surged as investors have sought to curb their exposure to swings in volatile Latin American economies.

"The activity helps firms in the region to manage their exposure to interest rates and currency risks," said Mark Brickell, managing director at J.P. Morgan & Co. in New York."And it helps investors outside the region invest more easily and manage the risk of their investments more capably."

More than $200 billion in options on Latin American government bonds has changed hands so far this year, up from $140 billion in 1994, said Francis Repka, who oversees emerging market operations at Societe Generale.

The interest in derivatives was sparked by the Mexican financial crisis in late 1994. Peso futures contracts were created to help investors shield themselves against big drops in the peso. More than 31,000 peso futures contracts were outstanding at the close of trading today on the Chicago Mercantile Exchange.

Derivatives are contracts whose value is tied to the price of some other asset, such as a stock, bond, or commodity. They can be used to protect against swings in markets or to make bets on the direction of securities, interest rates, or currencies.

So far, Latin America has avoided high-profile losses like the bankruptcy of California's Orange County or the collapse of Barings PLC, the British investment house.

And while derivatives trades might scare some governments, they also help governments by spreading out losses when they do occur.

"When problems occur, the people who are better able to absorb the risk end up with the losses," said Mr. Brickell. "It's a safety net."

Mexico has even begun to swap some of its Brady bonds for Eurobonds, which investors prefer because they are more flexible and allow more types of derivatives to be traded.

The new securities can also offer better returns. In Brazil, bankers sold $1 billion worth of new Eurobonds backed by outstanding government loans. Investors buying the new security were able to capture higher yields than those offered on comparable Brazilian government debt.

Latin American governments have been quick to allow derivatives trading where investors demand them. Still, some are beginning to keep tighter control over the trades.

Brazil's securities and exchange commission, CVM, is in the process of creating a new department solely devoted to monitoring the risk exposure of banks and securities firms, while Mexico's National Banking Commission is reviewing legislation that would give it similar control.

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