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Non-Tech : Derivatives: Darth Vader's Revenge
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To: Worswick who wrote (8)9/1/1998 10:28:00 AM
From: Henry Volquardsen  Read Replies (2) of 2794
 
Worswick,

Thank you for your very kind words. It is my pleasure. I have added this thread to my bookmarks so I will be staying tuned. I come to SI to find information from others so only consider it a fair trade if I can share what I know.

The Orange County risk was not really a major derivative risk. It was old fashion bungling. Derivatives are a nice obscure term to use if someone wants to demonize a situation. The reality of Orange County was that it was a pure and simple case of over leveraging. It was no different than buying stocks on heavy margin. OC was effectively buying term securities with borrowed money. The derivatives just made it easier. The blow up was the result of bad decision making not an unrecognizable risk.

Morgan's situation in Korea is a case of country risk. The banks in question were able and willing to pay off Morgan. It was the government who ordered them not to. This is no different than the situation in Russia where the government froze all payments by Russian banks to foreigners. I have seen this type of country risk elsewhere as well. It is very important for banks to set firm country risk limits and include those limits under derivatives. Again Russia is a good example of this. A lot of hedge funds were doing hedged GKOs which they believed were free money. Unfortunately for them they took Russian country risk on their hedges. It was the freezing of their hedges that caused the losses. I can remember looking at the same documents and deciding it was an unacceptable risk and therefore did not take the position. Many of those that did are now out of business.

Henry
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