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Sunday, July 12, 2009 9:46:46 AM
Subject: Derivatives
An Easily Understandable Explanation of Derivative
> Markets:
> >
> > Heidi is the proprietor of a bar in Detroit. She
> realizes that virtually all of her customers are unemployed alcoholics and, as
> such, can no longer afford to patronize her bar. To solve this problem,
> she comes up with new marketing plan that allows her customers to drink now, but pay later.
> >
> > She keeps track of the drinks consumed on a ledger
> (thereby granting the
> > customers loans).
> >
> > Word gets around about Heidi's "drink now, pay later"
> marketing strategy and, as a result, increasing numbers of customers
> flood into Heidi's bar. Soon she has the largest sales volume for any bar in
> Detroit.
> >
> > By providing her customers' freedom from immediate
> payment demands, Heidi gets no resistance when, at regular intervals, she
> substantially increases her prices for wine and beer, the most consumed
> beverages. Consequently, Heidi's gross sales volume increases massively.
> >
> > A young and dynamic vice-president at the local bank
> recognizes that these customer debts constitute valuable future assets and
> increases Heidi's borrowing limit. He sees no reason for any undue
> concern, since he has the debts of the unemployed alcoholics as collateral.
> >
> > At the bank's corporate headquarters, expert traders
> transform these customer loans into DRINKBONDS, ALKIBONDS and
> PUKEBONDS. These securities are then bundled and traded on international security markets. Naive
> > investors don't really understand that the securities
> being sold to them as AAA secured bonds are really the debts of
> unemployed alcoholics.
> >
> > Nevertheless, the bond prices continuously climb, and
> the securities soon become the hottest-selling items for some of the
> nation's leading brokerage houses.
> >
> > One day, even though the bond prices are still
> climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar.
> He so informs Heidi.
> >
> > Heidi then demands payment from her alcoholic patrons,
> but being unemployed alcoholics they cannot pay back their
> drinking debts. Since, Heidi cannot fulfill her loan obligations she is
> forced into bankruptcy. The bar closes and the eleven employees lose their
> jobs.
> >
> > Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in
> price by 90%. The collapsed bond asset value destroys the banks
> liquidity and prevents it from issuing new loans, thus freezing credit and
> economic activity in the community.
> >
> > The suppliers of Heidi's bar had granted her generous
> payment extensions and had invested their firms' pension funds in the
> various BOND securities. They find they are now faced with having
> to write off her bad debt a supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer
> supplier is taken over by a competitor, who immediately closes the local plant
> and lays off 150 workers.
> >
> > Fortunately though, the bank, the brokerage houses and
> their respective executives are saved and bailed out by a multi-billion
> dollar no-strings attached cash infusion from the Government. The funds
> required for this bailout are obtained by new taxes levied on employed,
> middle-class, non-drinkers.
> >
> > Now,..... you get the idea?
> >
JL
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