Latin American Capital Markets

338 A. M. CORCORAN, R. B. HOBSON, G. I. KUSERK, K. K. WUERTZ, AND D. WESTmind. Based on World Bank figures, Latin American countries are among the five leadingproducers of the following commodities: sugar the soybean complex, maize, copper;aluminum, iron, nickel, and oil. Seventeen Latin American and Caribbean countriesdepend on commodities for more than 50 percent (ranging from 56 to 91 percentin 1997) of their export earnings. Many Latin American jurisdictions are moving to developbenchmark sovereign debt markets. In each case, derivatives can be exploredas a potential means to enhance management of price volatility and improve the functioningof the cash market (World Bank 1999). In addition to a likely product, however,an accommodating macroeconomic environment, sound legal system, and wellfunctioningcash market are ordinarily preconditions for successful derivatives marketdevelopment, and such markets more often evolve than are created (see the appendixfor the experience of Brazil).Identifying Development Needs, a Product, and an ApproachIn general, derivatives are distinguished from other financial instruments because theirprimary use is for shifting market risk as opposed to raising capital.The basic types offinancial instruments that typically are included in the term "derivatives" are futures,options, swaps, and combinations of the foregoing.The common feature shared by alltypes is that they are contractual arrangements for providing opposite, but otherwiseidentical, market exposures to both contract parties. Derivatives can be based on currencies,interest rates, securities, physical commodities, or indexes representing valuesof groups of such instruments and assets. In recent years, derivatives with a value dependenton variables such as weather and crop yields have been developed. 2In addition to the direct benefits of hedging to commercial producers, consumers,lenders, and other middlemen, others involved in the production and distributionof commodities and financial instruments benefit from the availability ofcontinuous, well-publicized prices discovered in exchange-based derivatives markets.Indeed, wholesale (and sometimes retail) transaction prices in industries or sectorsthat produce or distribute goods or assets traded on active futures markets are oftenbased on the prices discovered in those overlying derivatives markets. 32 Insurance policies covering weather phenomena and crop yields have existed for some time. The primary distinctionbetween derivatives and insurance is that insurance payoffs generally depend on the loss incurred on the part ofthe insured. Derivatives payoffs are tied exclusively to changes in the underlying variable.3 For example, although much of the world's copper production is in Latin America, the world price is denominatedCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pubin dollars and based on London Metal Exchange/Commodity Exchange prices.