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Strategies & Market Trends : 2026 TeoTwawKi ... 2032 Darkest Interregnum
GLD 387.11+0.1%4:00 PM EST
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To: abuelita who wrote (31287)3/18/2008 8:18:25 PM
From: KyrosL  Read Replies (1) of 218176
 
The big problem with those trillions of derivatives held by banks and other financial institutions is that they are not very liquid and are very volatile. A credit default swap, for example, which is basically insurance for a particular company's bonds, can double or triple in value overnight based on a rumor about the company.

Because these instruments don't trade much, holders use models to value their positions. But different financial institutions use different models. So you have the paradox that banks on opposite sides of a particular trade both show a profit on the trade. They simply tweak their models appropriately <g>

The big nightmare is when a bank has to liquidate its positions. Then, all of a sudden, huge losses appear out of the blue. The market doesn't know about models <g> No wonder the Fed was terrified about Bear Stearns going BK and trying to liquidate its positions.

When Buffett acquired an insurance company a few years ago, he took a look at its derivatives portfolio that showed a nice gain and was horrified. He ordered it liquidated carefully and as quickly as possible. It took a number of years to do it and resulted in a loss of $400 million.
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