Derivative markets and how they work - K-Bikes.com - Excellence in Motion
 
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post #1 of 4 (permalink) Old Mar 28th, 2009, 11:47 am Thread Starter
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Derivative markets and how they work

Heidi is the proprietor of a bar in Detroit. In order to increase sales, she decides to allow her loyal customers -
most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger
(thereby granting the customers loans).

Word gets around about Heidi's drink now pay later marketing strategy and as a result, increasing numbers of
customers flood into Heidi's bar and soon she has the largest sale volume for any bar in Detroit.

By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when she substantially
increases her prices for wine and beer, the most consumed beverages. Her sales volume increases massively.

A young and dynamic vice-president at the local bank recognizes these customer debts as valuable future assets and
increases Heidi's borrowing limit.

He sees no reason for undue concern since he has the debts of the alcoholics as collateral. At the bank's
corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS.

These securities are then traded on security markets worldwide. Naive investors don't really understand the
securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics.

Nevertheless, their prices continuously climb, and the securities become the top-selling items for some of the
nation's leading brokerage houses.

One day, although the bond prices are still climbing, a risk manager at the bank subsequently fired due his
negativity), decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar.

Heidi demands payment from her alcoholic patrons, but being unemployed they cannot pay back their drinking debts.
Therefore, Heidi cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKIBOND drop in price by 90 %. PUKEBOND performs better,
stabilizing in price after dropping by 80 %. The decreased bond asset value destroys the banks liquidity and
prevents it from issuing new loans.

The suppliers of Heidi's bar, having granted her generous payment extensions and having invested in the securities
are faced with writing off her debt and losing over 80% on her bonds. Her wine supplier claims bankruptcy, her beer
supplier is taken over by a competitor, who immediately closes the local plant and lays off 50 workers.

The bank and brokerage houses are saved by the Government following dramatic round-the-clock negotiations by
leaders from both political parties. The funds required for this bailout are obtained by a tax levied on employed
middle-class non-drinkers.

Finally an explanation I understand ...

tim-----still on the right side of the frostline

you can't stop the signal
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post #2 of 4 (permalink) Old Mar 28th, 2009, 12:23 pm
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Sad to say, but that sums it up nicely. What kills me is these greedy bastards from oversees who failed to do their due diligence now want to blame us. This whole mess was driven by greed, and fueled by the Government under slick Willie's administration. They insisted on lending money to people they knew could never pay back, and allowed this whole derivative market to start in the first place. Prior to Clinton administration it was a felony to BET on a market you were not invested in, which is exactly how derivatives work.

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post #3 of 4 (permalink) Old Mar 29th, 2009, 1:37 am
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Quote:
Originally Posted by 2008-K1200GT
Sad to say, but that sums it up nicely. What kills me is these greedy bastards from oversees who failed to do their due diligence now want to blame us. This whole mess was driven by greed, and fueled by the Government under slick Willie's administration. They insisted on lending money to people they knew could never pay back, and allowed this whole derivative market to start in the first place. Prior to Clinton administration it was a felony to BET on a market you were not invested in, which is exactly how derivatives work.
Hey Dan, I think you might be a little harsh with the "greedy bastards from overseas" brushstoke.
The toxic assets that exist in the USA banking system and the near criminal behavior of the market there is whats causing this mess.
I have no sympathy for people who invested into high risk portfolios and after taking that gamble have done their money, thems the rules.
But the world economy is now fucked and even all the way down here where we have been relatively insulated by a very strong economy and a well regulated and run banking system , unemployment is escalating and we are now in recession.
Hard working people are feeling pain and losing assets that they have worked hard for that took no part in high risk schemes as a direct result of the behavior of Wall Street guru's.
Like I said I feel no sympathy for people who took risks with little to no due diligence however I think plenty of sympathy and empathy is deserved from your neck of the woods for the worldwide victims of this fuckup.

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post #4 of 4 (permalink) Old Mar 29th, 2009, 8:43 am
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Andrew, for sure we have our own greedy bastards, didn't mean to suggest it was all overseas, but the overseas crew seems to want to blame America alone, and here is my problem with that. If something sounds to good to be true, it is. That is to say, If I told you I had a lovely bridge to sell which connects Brooklyn to Manhattan, and you could have it to do with as you please for say 1 million, would you ask a few questions? You bet you would. Now the markets were preforming at lets say 7 percent, and the people who invested in the derivatives were taking in 10 percent. Why did they beleive they would out perform the markets without additional risk? Personally I think most of these investors didn't undersatand what they were investing in at all. They just wanted maximum returns. With maximum returns come maximum risk. In my way of thinking the American Congress specifically the Banking Comittee, and mostly, Barney Frank are responsible for allowing this deregulation. It was not long ago when derivates were a felony. Looks like that was with good reason. But the blame does not rest solely with America. Caveat emptor

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