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To: Amy J who wrote (174875)6/23/2003 12:16:03 PM
From: chomolungma  Read Replies (3) of 186894
 
I agree with Buffett on his point on derivatives. The USA government operates like a casino house.

Amy, it's the gambler who loses, the house is almost always profitable. Better pick another metaphor. <g>

But derivatives are very misunderstood. The numbers you generally see are the "notional value" of the contract. These are usually quoted for their shock value but grossly overstate the true risk of the instrument. I used to love to worry my wife and impress my buddies by telling them how many millions of eurodollars I was long/short in my commodity account. The eurodollar, is a short-term interest rate contract that obliges the holder to buy or sell one million 90 day eurodollars at a fixed rate. The margin is slim ($600) which reflects the chance of a big move being small. Short rates would have to change 100 basis points to get you a $2,500 loss or gain. So you see, the chance of losing that $1,000,000 is non-existent.

Yes, there are abuses in the derivative's market. Most of these are done by overuse of leverage. Long-term capital was leveraged to the hilt because their Nobel-Prize winners underestimated the volatility of their markets and felt that they could never be wiped out. They were wrong. To assume that all derivatives are equally leveraged is a reckless assumption. [EDIT] So simply stating the notional value of derivative contracts says little about the actual risk to the system.
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