frank miller

[Robert Mahnke]

Imagine a poker game, and the players are betting on the game.

Now imagine that there are a bunch of people around the game, who are not
playing, but who are betting with each other on the game.  Those side bets
are derivatives.  (They're derivative of the action in the game.)

There are legit reasons for businesses to want to hedge risk with
derivatives.  For example, you might have own a bunch of General Electric
bonds.  You want to protect yourself from the risk that GE will default on
those bonds, so you buy credit default swaps, which work like insurance.
You make regular payments to whomever you're dealing with, and they agree
to pay you a larger sum in the event that GE defaults on the bonds.  You've
just hedged your exposure to a default by GE, at the cost of the regular
payments, and with the caveat that you have some risk that the counterparty
you're dealing with with fail, rendering the insurance worthless.

Or suppose you run a US business that sells lots of stuff in Europe, and
you are exposed to the risk that the Euro will drop in value before you can
turn your European earnings back into dollars.  You might enter into FX
derivatives structured so that you will make money if the Euro drops in
value and lose money if the Euro gains in value.  This isn't a credit
default swap, but again you've found a way to hedge some risk, and perhaps
by dealing with a party that has the opposite problem.

Not to say (not at all) that they have no downsides -- they allow financial
institutions to greatly increase their leverage, with massive systemic
risks. Still, they exist because they have some legitimate uses.


On Tue, Nov 29, 2011 at 5:19 PM, Michael Bailey <
michael.lee.bailey at gmail.com> wrote:

>  alice wellintown  wrote:
> >
> >  Also, you
> > don't know what a derivitive is. do you?
> >
>
> I would love to read an explanation by you.  You have an interesting
> prose style.
>
> I have read up on them a little but, because I'm not a deep thinker,
> they seem to me to be the type of thing that embodies the worst
> aspects of capitalism:
>
> they are basically gambling (which I don't approve of)
>
> they are a zero sum game: for every winner there's a loser
>
> they are prone to manipulation and speculation, allowing people for a
> minimal investment to damage or even destroy companies that otherwise
> could fill human needs
>
> they feed an effete corps of profit-takers who produce nothing, but
> whose money competes for things and services that are actually worth
> having in their own right
>
> they produce profits disproportionate to the amount of value (if any)
> that they add - which distorts the marketplace for everything else and
> draws talented people who could be gainfully and probably more happily
> employed in ever so much more useful pastimes
>
>
>  how wrongheaded and stupidl am I, to think such things?
>
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