1. There are a number of ethical ramifications associated with derivatives. The first being the derivatives expose investors to counter-party risk. Say a business wants a fixed-interest loan but banks only offer variable rates. The business can then swap payments with another business that wants the variable rate given out by the bank. This in turn gives a fixed rate to the business that did not want a variable rate. However, say the second business goes bankrupt. This means that the first business loses its fixed rate loan and has to start paying the variable rate. If interest rates increase to the point where the first business cannot pay back the loan, it causes a chain reaction of business failures. The second ethical issue that comes with derivatives is the fact that derivatives can pose a high amount of risk for the small and inexperienced investor. Inexperienced investors are attracted to the fact of making a lot of money off of derivatives but they do not comprehend the fact that derivatives makes the investor assume additional risk. This can cause the individual investor to lose a lot of money, which in turn can cause domestic or economic crisis. Ultimately, ethical issues in derivatives are dependent on the managers and traders that utilize them. We could say that the promise of supreme profits can corrupt the small investor or trader. The trader must understand the amount of risk he is prepared to undertake as well as communicate that risk to the investor or stakeholders. Traders and investors got so caught up in the money they were making that they forgot to care about the stakeholder, which in turn led to backlash and economic crisis.
2. The main difference between making a bad business decision using derivatives and engaging in unethical conduct using derivatives would be that you are unknowingly making a bad business decision. You have the mindset