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This research proposal provides details about a planned research project on innovative financial instruments. The area of finance has been characterised and marked by continuous innovation, which in turn has resulted in the development of a multitude of financial instruments, including mortgage backed securities, collateralised debt obligations, credit swaps and retail structured products amongst others. The proposed research project will aim to examine and analyse innovative financial instruments from various aspects, including history and evolution, utility and risk and risk management.
The research for the project will be carried out through the use of a critical literature review, followed by the discussion and analysis of findings.
Table of Contents
This research proposal provides details about the conduct of a study involving the examination of various aspects of innovative financial instruments in order to achieve a comprehensive understanding of their evolution, their scope, their utility, their advantages, limitations and associated risks.
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A Financial instrument can be described as a tradable asset or a tradable package of capital (Nejad, 2016). The majority of financial instruments help in the provisioning of an effective transfer and flow of capital throughout investors across the world (Nejad, 2016). Such financial instruments can be either real or in the form of virtual documents that represent legal agreements involving financial value (Nejad, 2016; Bernholz & Vaubel, 2014). Dabrowski (2017) stated that financial instruments, which are equity based, represent asset ownership, whereas financial instruments that are debt based represent loans made by investors to asset owners. Foreign exchange instruments are also included in the range of financial instruments (Dabrowski, 2017; Bernholz & Vaubel, 2014). Such financial instruments have been described as contracts that result in financial asset of a specific entity and an equity instrument or financial liability of another (Dabrowski, 2017; World Economic Forum, 2012).
The area of finance and the modern financial system has been characterised by continuous innovation over the years and especially so in the course of recent decades. Bernholz and Vaubel (2014) stated that continuous innovation in this area has resulted in the generation of numerous new products, including tax deductible equity, derivatives, risk transfer products and exchange traded funds. The area has furthermore received substantial attention in recent years on account of the perceived role of innovative financial instruments in the development and growth of the financial crisis (Bernholz & Vaubel, 2014; World Economic Forum, 2012).
The area of innovative financial instruments is very truly extensive, complex and an interesting area for further research.
1.2. Aims and Objectives
The proposed research project will aim to study, examine and analyse innovative financial instruments from various perspectives in order to achieve a broad and comprehensive understanding of the subject.
The objectives of the study are detailed below.
- To examine and study the evolution of financial instruments over the years and the ways in which innovative financial instruments have developed from time to time.
- To study and examine the various types of innovative financial instruments, with specific regard to their utility, advantages and limitations.
- To study the role of financial instruments in the modern global economy.
- To examine and analyse the risks associated with innovative financial instruments and the ways in which such risks can be governed and controlled.
2. Preliminary Literature Review
The examination of available information on financial innovation reveals that it has been a persistent and vital element of the economic landscape in recent centuries (Dabrowski, 2017; European Commission, 2011). Appel (2015) stated that financial markets have produced and continue to develop numerous new products. Gounaris and Koritos (2008) added that financial innovation, like business innovation is a continuous and ongoing process that stems from the experimentation of various private parties and their attempts at product differentiation in response to progressive, gradual and sudden alterations in the economy.
Ozdemir and Trott (2009) informed that financial innovation intensified since the 1960s and have since then continued unabated across the developed economies; it has resulted in the development of major alterations in the financial environment and landscape. Whilst the process of financial innovation varies from nation to nation, it has several common attributes, which include (a) the development of new financial products and markets, (b) securitisation and an increasing tendency for market influenced rates of interest and financial instruments that are marketable rather than loans from banks, (c) the liberalisation of financial market practices through specific deregulation and the elimination of conventions, (d) globalisation, characterised by the erosion of national barriers and the integration of financial markets and (e) greater competition between various types of financial institutions (Sandor, 2012; Eriksson et al., 2008).
An important aspect of this process has been the development, introduction and implementation of a wide range of new and innovative financial instruments that are traded in fresh market settings and lower the dependence upon banks for credit assessments and traditional credit instruments (World Economic Forum, 2012; European Commission, 2011). Several of these new products, like for example interest and currency rate options and interest and currency rate swaps help in risk management and facilitate individuals or firms in tailoring the various dimensions of risk. Other products appear to help in reducing the cost of funding (World Economic Forum, 2012). Nejad (2016) added that the basic principles that underlie new and innovative financial products are being reapplied and extended to develop new products.
To approach innovative financial instruments from the perspective of associated risk, Eriksson et al., (2008) stated that issues of inadequate and inappropriate valuation along with poor risk management in the utilisation of credit derivatives has been at the core of credit market turmoil. Substantial debate and discussion has occurred over the utilisation of instruments like credit default swaps, mortgage backed securities and collateralised debt obligations (Eriksson et al., 2008; European Commission, 2011). The emergence and development of the crisis has resulted in queries on the measurement of the risk of innovative financial products and the ways and means that can be employed to manage them (Sandor, 2012; European Commission, 2011). European Commission (2011) stated that innovative financial instruments were by and large illiquid and their use could result in the emergence of different types of challenges with regard to their valuation and the management and measurement of risks that were associated with them.
Nejad and Estelami (2012) stated that innovation in financial instruments has assumed two specific states, namely variations on diverse existing categories of instruments and instruments that have been introduced for new classes of risks. The various types of innovation result in the development of specific sets of issues (Nejad & Estelami, 2012; Eriksson et al., 2008). Sandor (2012) on the other hand stated that the targeted use of innovative financial instruments could help in attraction of private sector participation and the unlocking of investment through the distribution of risks to those who were best able to bare and absorb it.
3. Research Method
It is proposed to carry out the research for the planned research project with the help of a critical literature review of the available information on the subject. The area of financial innovation has attracted substantial researcher interest and a wide body of information has been created on the subject. The research method will thus involve the online search of available information with the help of appropriately selected keywords, phrases and search terms. Such keywords shall focus on the evolution and history of innovative financial instruments, the characteristics and types of such instruments, the utility of such instruments and the various types of risks associated with their use. Specific focus shall be placed on the role of innovative financial instruments in the development of the global financial crisis.
The conduct of rigorous online search shall result in the preliminary identification of different information sources (Bryman & Bell, 2007; Saunders et al., 2007). These information sources will thereafter be categorised and thereafter examined in depth with regard to four specific factors, i.e. their relevance to the research study, the reliability and reputation of the authors and publishers, the presence or lack of bias in the information sources and their frequency of citation (Saunders et al., 2007; Gomm, 2008). The information sources selected from such an examination shall be subjected to critical review, followed by their comparison, contrasting and analysis in order to arrive at suitable findings (Gomm, 2008; Saunders et al., 2007). The findings of the literature review will thereafter be taken up for critical discussion and analysis in accordance with the research themes and the aims and objectives of the study. The research approach shall very obviously be interpretive / qualitative in nature.
4. Challenges and Limitations
The proposed research project is extremely complex and the area of innovative financial instruments has attracted significant researcher interest. With the research involving the use of critical literature review, it shall involve the conduct of rigorous online search, followed by the comparison and contrasting of information in order to arrive at appropriate findings. This process is likely to be extremely challenging, but efforts shall be made to complete it satisfactorily.
Appel, S., (2015), Experience with financial instruments in the period of 2007-2013 an the new framework for the period of 2014-2020, Brussels: European Commission.
Bernholz, P., & Vaubel, R., (2014), Explaining Monetary and Financial Innovation: A Historical Analysis, NY: Springer International Publishing.
Bryman, A., & Bell, E., (2007), Business research methods, 2nd edition, Oxford: Oxford University Press.
Dabrowski, M., (2017), “Potential impact of financial innovation on financial services and monetary policy”, Available at: http://www.case-research.eu/uploads/zalacznik/2017-07-18/Potential_impact_of_financial_innovation_on_financial_services_and_monetary_policy.pdf (accessed September 05, 2018).
Eriksson, K., Kerem, K., & Nilsson, D., (2008), “The adoption of commercial innovations in the former Central and Eastern European markets: the case of internet banking in Estonia”, International Journal of Bank Marketing, Vol. 26, Iss (3): pp. 154-169.
European Commission (2011), “A Framework for the Next Generation of Innovative Financial Instruments – the EU Equity and Debt Platforms”, Available at: ec.europa.eu/economy_finance/financial_operations/investment/europe_2020/ documents/com2011_662_en.pdf (accessed September 05, 2018).
Gomm, R., (2008), Social Research Methodology: A Critical Introduction. 2nd edition, UK: Palgrave Macmillan.
Gounaris, S.P., & Koritos, C.D., (2008), “Using the extended innovation attributes framework and consumer personal characteristics as predictors of internet banking adoption”, Journal of Financial Services Marketing, Vol. 13, Iss (1): pp. 39-51.
Nejad, M., (2016), “Research on financial services innovations: A quantitative review and future research directions”, International Journal of Bank Marketing, Vol. 34, Iss (7): pp.1042-1068.
Nejad, M.G., & Estelami, H., (2012), “Pricing financial services innovations”, Journal of Financial Services Marketing, Vol. 17, Iss (2): pp. 120-134.
Ozdemir, S., & Trott, P., (2009), “Exploring the adoption of a service innovation: a study of internet banking adopters and non-adopters”, Journal of Financial Services Marketing, Vol. 13, Iss (4): pp. 284-299.
Sandor, R.L., (2012), Good Derivatives: A Story of Financial and Environmental Innovation, John Wiley & Sons: Hoboken, NJ.
Saunders, M., Lewis, P., & Thornhill, A., (2007), Research methods for business students, 4th edition, London: Prentice Hall.
World Economic Forum, (2012), Rethinking financial innovation, World Economic Forum: Geneva.
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