Financial Literacy

Financial Literacy Student Name Institution Professor Name Course Date Financial Literacy Topic e: The Role of Derivatives on Climate, Energy, and ESG Finance- Innovating for Sustainability and Risk Management Derivatives are essential in the current financial world and are used as efficient hedging tools and financial innovations. In Barrera’s (2024) view, financial instruments are derived from other assets such as stocks, bonds, commodities, or stock exchange indexes. Investors and financial institutions in almost all financial sectors can use derivatives to hedge and speculate.  One of the most important applications of derivatives is hedging. They assist businesses and investors in minimizing the potential loss that may arise from fluctuating prices, rates of interest, or exchange rates. As Barrera (2024) states, a firm that buys raw materials from overseas can use currency futures to hedge against unfavorable exchange rate changes, which would lock in costs and, therefore, margins.  In climate, energy, Environmental, Social, and Governance (ESG) finance, the derivatives are gradually becoming increasingly important to the market. Similarly, Zhao et al. (2018) claim that global society is yet to address climate change and shift towards renewable energy. However, the emergence of new financial risks means that they are being accompanied by new financial instruments. For example, weather derivatives enable organizations in fields vulnerable to weather conditions to invest in it (Zhao et al., 2018). These instruments can enable for option on some forms of weather occurrences or patterns to be compensated, this can be an advantage, particularly for firms wishing to minimize the effects of hostile weather conditions. Narassimhan et al. (2018) pointed out that futures in carbon credit have evolved to enable the trading of carbon emissions permits. They allow for controlling emissions and achieving the desired levels of greenhouse gases in the economy by companies. Thus, the carbon derivatives market will remain useful for reporting and promoting investment as the governments in various countries develop initiatives aimed at reducing the use of carbon.  Energy futures and options on oil, natural gas, and electricity help manage the price risk in energy markets. According to Barrera (2024), these instruments assist producers, distributors, and large consumers in hedging the price. It, in turn, provides them with improved cash flows and fewer fluctuations in their business. Moreover, when new energy sources, such as wind and solar come into the energy market, new products are introduced based on the uncertainty of energy from such sources. Other related derivatives that have come out in this area are ESG-linked deriva...