Derivatives

For starters, this comment from the site, questions the use of the "notional value"... a valid question.

To quote you “Most people don’t talk much about derivatives because they simply do not understand them”.

I’m afraid your posting uses the notional size of the contracts instead of the actual financial risks which are far smaller. You’ve picked on giant numbers and metaphorically arm waved and spread fear and doubt.

For each derivative contract, you need a ‘notional’ number which is the amount of money to calculate payments on – the actual payments and therefore amount at risk, is derived from those numbers, and comes down to much smaller amounts.

e.g. an interest payment on a $100m interest rate swap, where the difference between the fixed and floating rate could be as low as 0.5% would be $500k, hardly a mind boggling amount. And yes these amounts add up, but not the to vast amounts you’re suggesting. Have a read about the bond market – really big amounts, those are the ones to worry about.

At the moment, the problems with the world economy are driven by over-borrowing, simple stuff. The derivatives in the world are little to do with how some European countries and one north american country have borrowed too much.
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IMO The original article and this response lay the groundwork for questioning the level of risk involved.
 
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I would agree that notional isn't as relevant to risk.

For example, you would buy an at the money call option on 1000 shares of a $50 stock for much less than the $50,000 value of 1000 shares of the stock. Lets say an at the money call on 1,000 shares would cost $1,500 for discussion purposes.

Your profit or loss would be (the change in the price of the stock over the term * 1000 shares) - your $1,500 cost. So if the stock was unchanged or went down you would lose $1,500. If the stock increased $5 you would make $3,500. If the stock increased $2 you would make $500. And if the stock increased $1 you would lose $500.

So in this simple example the "notional" is $50,000 ($50 * 1000 shares), but the amount at risk is only the $1,500 you paid for the calls.
 
Derivatives are like power tools, opiates and firearms. Not inherently good or bad in and of themselves, it is what you do with them that matters.
 
I suspect the risk varies all over the map thus the need for at least minimal regulation/oversight. It seems like that notional concept applied pretty directly to the credit default swaps that brought down the house.
 
ER.org has a new self appointed provocatuer I see...pass.
 
What would you like to discuss? Obviously,notionals do not equate to risk directly. Though they form the starting point to calculate and ultimately control risk.
 
Danmar said:
What would you like to discuss? Obviously,notionals do not equate to risk directly. Though they form the starting point to calculate and ultimately control risk.
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I'm quite sure that there is little interest or understanding here on the amount of risk involved in the ether of derivative contracts. The notional value amounts that are bandied about, should at the very least make one wonder what this is all about. Just because talk of hundreds of trillions is so unreal, the numbers are dismissed as fantasy.

Most people have no idea of:
- The hundreds of different types of derivative contracts.
- The slicing and dicing of agreements that are backed by mathematical formulas that can run to five pages, mostly based on initial ratings that often have no basis in research... or reality.
- What part of their lives are invested in derivative agreements that will vary for 30 years in the future.
- Why Credit Default Swaps? Why not "shares"?
- Who holds these investment instruments? Pension Plans, Insurance Companies, Endowment funds, Cities, Municipalities, Banks...
- That the people on the governing boards who oversee investments (above)
have little or no idea of the risk level, other than what the broker tells them.
- How are derivatives settled? Payouts over days, months, years, decades.
- Why individuals don't trade derivatives?
- What happened when Warren Buffet tried to unravel the General E accounts
Derivatives, as Accused by Warren Buffett - NYTimes.com
- The virtual impossibility of knowing... the basis of valuing accounts.
- The darkness of the trading rooms. Even with the proposed new regulations.
- What part of the assets of the five largest banks is invested in derivative accounts.
- The CFTC has virtually no control over derivative trading, despite recent legislation.
- What Brooksley Born warned about.

These issues hardly scratch the surface of concern.
It is much easier to brush off "impossible" numbers than to really understand the threat to the world economy. That's the attitude of our Congress.

Complicit in all of this, is the mainstream media, which shrinks down the word "derivatives" and wraps it in cotton candy, effectively taking it out of the public consciousness.

Often better to let the sleeping dog lie.
 
Go read a few graduate level finance textbooks and we can talk
 
imoldernu said:
I'm quite sure that there is little interest or understanding here on the amount of risk involved in the ether of derivative contracts. The notional value amounts that are bandied about, should at the very least make one wonder what this is all about. Just because talk of hundreds of trillions is so unreal, the numbers are dismissed as fantasy.

Most people have no idea of:
- The hundreds of different types of derivative contracts.
- The slicing and dicing of agreements that are backed by mathematical formulas that can run to five pages, mostly based on initial ratings that often have no basis in research... or reality.
...
Click to expand...
So what are you (or others on this thread) doing about derivatives concerns? Does it affect your investment process at all? Do you practice buy-hold or have a Plan B?

Seems more important to me to have a plan of action then to just worry about the issues.
 
Doesn't somebody have a rule about not investing in things he doesn't understand? He seems to have done okay with that philosophy.
 
Bestwifeever said:
Doesn't somebody have a rule about not investing in things he doesn't understand? He seems to have done okay with that philosophy.
Click to expand...
This isn't about investing, it's about worrying. It's a lot easier to worry about something when you don't understand it.
 
:cool::LOL:
img_1217790_0_b2c35adf046c2f5979990b79167a2077.jpg


Jumps in Financial Markets: A New Nonparametric Test and Jump Dynamics
 
MichaelB said:
This isn't about investing, it's about worrying. It's a lot easier to worry about something when you don't understand it.
Click to expand...

Certain people seem to get a sort of perverse enjoyment from worrying about such things. They need to get out more.
 
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