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Non-Tech : Derivatives: Darth Vader's Revenge
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To: Henry Volquardsen who wrote (9)9/2/1998 2:15:00 PM
From: Worswick  Read Replies (1) of 2794
 
Henry thanks so much for your reply and taking us through the difficult thickets of the derivative world. I'd like to ask you a few question if you would put up with my probably naive grasp of the world of derrivatives.

You wrote: "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."

My question is wasn't Orange county putting out there a bet on the direction of interest rates and they simply got caught in front of the wave and crushed?

I know the term "derivative" is a melange sort of terminology for a wide variety of hedging instruments. In the world of derivates as a professional what is the instrumentality that posses the greatest amount of risk in the next, say, three months? I wonder your opinion of the instruments...and their risk as a long term observer of the field.

What are GKO's?

If you can still bear with me ... finally, let's go to a real world situation here for a moment. In the next 430 to 60 days Latin America will attempt to roll over huge amounts of short term paper. Presumably, the market will take to this like fire ants in inside of say... your old Boy Scout uniform.

Now, assuming we have a debacle here (amongst others circling round us like particularly aggressive misquitos) then bond pirces will drop creating.... the dreaded GAP downwards. Presumably, the bank's workman like well managed and of course well studied little hedges on these bonds will work. Each side of the trade will do the right things and we will all be fine. Right?

However....however...what if already weakened American banks, German banks, Japanese banks can't pick up their legs of the trades?

It seems to me we have country risk, event risk, and interest rate risk here.

... is this a recipe for the future?


My very best to you and thanks for putting up with these probably uninformed questions,

Clark

Nb. As a military history fan I wonder if you remember Henry the specifics of the British retreat from Kabul(Afganistan) on Christmas day of 1841? Do you recall the outcome?(*) This is the sort of thing I fear in the derivative world.

(*) ...as historian of the subcontinent I'll tell you if you don't know.
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