The first major shock to the derivatives world was the market crash of October 1987, when futures markets around the world only barely escaped the ignominy of Hong Kong, where the futures exchange was forced to close for several days. Since then, there has been a series of "blow-ups" where the use of derivatives has caused problems; most recently in the cases of Orange County and Barings.

Because derivatives can be traded so easily - on similar exchanges and through the same brokers as those for shares - it is tempting to regard these new instruments as like shares but with added zip. Herein lies the problem. Much confusion has been caused by the failure of investors to realise the fundamental difference between shares and derivatives.

This difference is not simply a matter of leverage, but rather the nature of the relationship between investor, broker and instrument.

For example, equity investors are used to dealing with stock-brokers who act as agents. However, if they then trade derivatives through (effectively) the same broker, that broker may well now be acting as a principal in the transaction.

One of the most critical differences between shares and derivatives is that the former are assets while the latter contracts. The significance of this is sometimes obscured by,

• brokers, who do not want to discourage their clients from dealing, and
• clients themselves, who do not want to be bothered to read the small print.

Equity investors have not traditionally concerned themselves much with credit analysis. However, this analysis should become more important with increasing exposure to derivatives - or at least contact with other companies who have that exposure.