Understanding Derivatives

[hd2000fxdl 422]

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 a new marketing plan that allows her customers to drink now, but pay later.

Heidi 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 because he has the debts of the unemployed alcoholics as collateral!

At the bank's corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS.

These "securities" then are bundled and traded on international securities markets.

Naive investors don't really understand that the securities being sold to them as "AAA Secured Bonds" really are 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 still are 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 Heidi's 11 employees lose their jobs.

Overnight, DRINKBOND prices drop by 90%.

The collapsed bond asset value destroys the bank's 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 BOND securities.

They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds.

Her wine 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 multibillion dollar no-strings attached cash infusion from the US Government.

 

The funds required for this bailout are obtained by new TAXE$ levied on employed, middle-class, nondrinkers who have never been in Heidi's bar.

 

Now do YOU understand?

 

[Malsua 1,422]

That analogy is missing part.

 

You forgot the Credit Default Swap issuer, like AIG.

 

Add in there that since Heidi isn't quite sure if her unemployed alcoholics will pay, decides to buy insurance. Along comes a guy from GIA who says that for 10% on the dollar of the outstanding debt owed by each Alcoholic, they'll cover the entire debt in the event of a default

 

Word gets around that GIA is taking action on the Alcoholic debt so everyone in town, including the alcoholics drop a few bucks to get in on the action. For every dollar you pay GIA, you get 10 dollars if an alcoholic fails to make payment. The executives at GIA now drive around in exotic sport cars because of all the action they're getting on the Alky debt.

 

Once the Alky's default, Heidi and the entire town goes to GIA and asks for the value of the insurance policy but that amount bankrupts the entire GIA enterprise. The executives keep all the money that rolled in but turn out their pockets and shrug when it comes time to pay.

[Dan 177]

Good one guys. Not many people understand what really went down. And the few that do feel powerless to do anything about it.

[djg0770 481]

And here I thought this would be a lesson on dx/dt.

[mipafox 438]

And here I thought this would be a lesson on dx/dt.

 

That would more commonly be referred to as a differential equation, not simply a derivative (as found in HS calc.).

[djg0770 481]

That would more commonly be referred to as a differential equation, not simply a derivative (as found in HS calc.).

 

Your pushing me to my limit... I don't find your comment integral to the conversation. /pun off

[tommy3rd 132]

And here I thought this would be a lesson on dx/dt.

or in chemistry, where derivatizing a compound means creating a derivative of the original.

[Dan 177]

I installed a Proportional - Integral - Derivative (PID) temperature controller on my espresso machine. Does that count for anything?

[Soju 153]

My head hurts.

[ExpendableRaj 1]

Came here to read something interesting, but all I got was a stupid chain e-mail.

 

beee deeee deeee deeeee oooooo beeeee dooooo eeeeeeeeeeee ooooooooooo

 

That's the sound of my AOL 3.0 dial up, it says it wants its chain emails back.

[ar15bang 0]

How about this one for mortgages.

 

http://online.wsj.com/article/SB10001424052970203501304577086722967995982.html