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Non-Tech : Derivatives: Darth Vader's Revenge
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To: Worswick who wrote ()8/31/1998 1:43:00 PM
From: Henry Volquardsen  Read Replies (2) of 2794
 
$750 billion is the notional amount of the derivative contracts that LTCB holds. The risk on these contracts is less than that and $750 billion did not 'just go to money heaven'. As an example take an interest rate swap for $100 mln. The $100 mln will count in total towards the amount of derivatives but the only economic risk will be the value of any change in interest rates. Compare this to being long a bond. If you're bond counterpart goes bankrupt you lose everything but if market rates move such as the bond price drops by 10%, you only lose the 10%. The derivative will lose the equivalent of the move in the bond price.

Also the total of LTCB deals probably includes a lot of deals that are offsetting. So in all likelihood they have deals with both gains and losses.

In addition the interbank derivatives market has gotten very sensitive to credit risk. A lot of features have been introduced to mitigate credit exposure. Features such as mark to markets, break clauses, collateralization and margining. The Japanese banks have been a headline problem for several years. LTCB in particular has been at the top of the problem list. The market has not been allowing them to deal without credit enhancement. I know this for a fact. There may be hidden derivative losses out there but I doubt LTCB will be one. The market has been on top of them for a while.
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