In a nutshell, a derivative is a financial insurance policy. They are typically cheap because they reflect the (typically very low) probability of the insured condition coming to pass. Derivatives are typically used as hedges to other bets.
That being said, if the “improbable” happens, there won’t be enough $$ in the world to pay these off. The Banks that sold them look at it as free $$, but G-d help them if the bill comes due. Kinda like a bookie to who can’t pay off his bets.
Can you tell me where to find a list of the different derivatves?
Can you or I trade some derivatives?
Where are their prices listed?
Do some mutual funds invest in derivatives?
“there won’t be enough $$ in the world to pay these off”.
There already is not enough to pay them off. The Bank of Intl Settlements (BIS) receives voluntary reports on the amount of derivatives world-wide. The derivatives are long term borrowings (as long as 30 years as with mortgage backed securities), and credit default swaps insure the other derivatives. All derivatives have essentially no adequate capital behind them. Multiple credit default swaps (Ponzi) exist on the same notionally valued equity as “naked” insuring is allowed in the completely unregulated derivative adventure with short term interest due during rollover periods on long term debt obligations.
The BIS up to two years ago reported the risk period for interest adjustment rollovers at 5 year intervals, and then reduced it to 2.5 year intervals...the recent reports of $700T of derivatives represents only half of the former 5 yr period total. So, over the usual short-term rollover period of 5 years, there are really about $1.5Quadrillion of derivatives. There will be 6 5-year rollover periods over 30 years. The 2008 rollover can go to 2013 for completion of the first rollover period. THE WORLD IS NOT GOING TO MAKE IT FOR THE FIRST OF THE SIX short 5 yr term rollover periods. Here is why:
The world GDP, generously, is about $68T this year, and assuming a 20% world tax base in the best of circumstances, there is only a maximum $13T world-wide tax base for running governments, etc. and guaranteeing bank losses on derivative values as is best demonstrated in this country ($16T went out for bank interest payment bailouts on derivative bond losses 2008-2010).
The $1.5Quadrillion of world-wide derivatives, say at 1% interest due each year and paid by the end of the 5 year periods, $15Trillion a year, or $75Trillion each 5 years out to 30 years, fully exceeds the entire tax base of this planet. The world will not make it. Over 30 years the total interest due at a conceptual 1% on the current “book” of derivatives world-wide approaches
5 x $75T = $375Trillion.
There are about $5B ounces of gold on the planet’s surface that is known. At $1000 an ounce, it is worth $5Trillion. Is it useful to use it as a standard for underwriting $1.5Quadrillion and growing of credit derivatives?
One additional problem is that derivatives and their additionally piled on insurance policies are growing, and the bankers and investment houses wish to add even more derivatives not seeing that there must be an end point.
>>>In a nutshell, a derivative is a financial insurance policy. They are typically cheap because they reflect the (typically very low) probability of the insured condition coming to pass. Derivatives are typically used as hedges to other bets.<<<
Maybe at one time they were used as hedges (to insure your own liability), but not anymore. Now you get Soros types betting on the failure of the dollar and then going about every way he can to destroy the American market.
I heard it described as like being able to buy fire insurance on your neighbor’s house. Because you don’t have a stake in the house not burning down (i.e., ownership), you have no reason to care if it does burn down, and maybe you even leave some gasoline and matches nearby, in hopes of someone doing your dirty work for you.
Furthermore, since every one of your neighbors can buy fire insurance on your house, the payout, if your house does burn down, isn’t the value of the house, but the value of your house times the number of derivatives sold on it.
Derivatives should be outlawed if you don’t have a vested interest in the underlying product.
If the derivatives can’t be paid off, it won’t be because of the derivatives, it will be because bad government policy in the EU, US, China, and Japan crashed the world economy. Absent a systematic economic failure caused by out of control government, derivatives markets will be of no particular concern.
I would wager that the government parasites will cause the world economy to collapse and will then try to blame it on derivatives, markets, banks, global warming, and, of course, Bush.