Derivatives: Darth Vader's Revenge Message Board

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Non-Tech : Derivatives: Darth Vader's Revenge

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To: Worswick who wrote (13)	9/2/1998 2:47:00 PM
From: Henry Volquardsen	Read Replies (1) of 2794

Hi Clark, 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? Yes that is what happened. But they used leverage to increase the position. No different than a margin call in the equitites market. If they just bet on interest rates they would have lost money but not been wiped out. It was the extra positions acquired with debt that lost them enough additional money to wipe them out. But at its simplest level they, as you say, bet on rates and got crushed. As far as what derivative has the most risk right now, that is tough to say. There are so many exotic risks out there that I don't believe everyone understands. There is always someone who is willing to do something he doesn't understand because everyone else is doing it. But I'll give you a risk that I personally believe is the worst. The market is good at analyzing economic, credit, settlement, cross border risk etc. We are very focused on those. What many people don't focus as well on is back office and systems risk. Many shops allow their front line people to push ahead into new products well before the systems are buttoned tight. The loss from credit exposure and bad market decisions get the headlines. But I will tell you that from my observation more money is lost year in and year out becuase of indaequate systems. Remember Joe Jett? Remember Nick Leeson? Remember Merrill losing hundreds of millions in mortgages in the mid 80s? There are plenty more. All because of inadequate internal controls or analytics. These loses dwarf the loses due to credit or bad trading calls. GKOs are Russian Rouble denominated treasury bills. Re your scenario, yes we have country, event and interest rate risk. That is the recipe of the future. My belief is these risks are manageable and not to be feared. If managed correctly thay are not insurmontable. But the truth of the matter is the world is more complex and as a result risks are more complex. But the system is more aware of these risks than they were 25 years ago and, for the most part, can cope. BTW re your question regarding the retreat from Kabul, if such a scenario develops in the derivatives market I'll be the one with the flag wrapped around my waist ;) My favorite book on the subject is "Flashman". Henry

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