Derivatives, also called futures contracts, are financial instruments whose value is derived from an underlying asset (Sivy, 2013). These are bets between two parties whose payoff is based on the future value of the asset and can be derived from fluctuating factors such as interest rates, stock indexes, mortgages or even the weather (Rickards , 2012). Warren Buffet comments that “we view derivatives as time bombs, both for the parties trading them and for the economic system.” I agree with his statement because derivatives are complex and unstable. It is unclear when they could explode, causing a new financial crisis. Although many factors contributed to the recent financial crisis, derivatives such as mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) had a significant impact on the events that occurred. . In the MBS market, the cash flow from a mortgage loan is divided into different parts and then sent to whoever can best manage the different risks at the best price. These elements are then repackaged into new financial instruments which are sold to investors (Rickards, 2012). The new wallets were used to secure collateralized debt obligations (CDOs) which were divided into tranches and sold to investors (Hull, 2011). These wallets were guaranteed by the government's National Mortgage Association (GNMA), which allowed banks to lend money without worrying about borrowers defaulting. Banks were able to generate profits by lending their money. Risk-created securities allowed banks to make money without keeping the risk on their balance sheets. As more loans were taken out to buy homes, property prices rose and lenders had to introduce low interest rates for...... middle of paper ... purchase options long term that would either be profitable or expire worthless. Goldman never explained the trades before they were made and had to be tracked down for information about the trades. Banks like JPMorgan and UBS have suffered the cost of what happens when you get into derivatives trading. The derivatives market is extremely complex and not very transparent. Since most transactions are done over-the-counter, it is difficult to determine the true market value. The entire market is supported by a small amount of liquidity, so if it were to collapse, the losses could amount to more money than the world has. The financial crisis should have been a warning to reduce the use of derivatives, but instead it grew. With this in mind, derivatives can be seen as time bombs. It's only a matter of time before the next financial crisis occurs because of derivatives.