Derivative Market ExplainedFrom a friend.
Ed
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----- Original Message -----
From: John McGrath
To: Ed Weick
Sent: Wednesday, May 19, 2010 7:44 AM
Subject: Derivative Market Explained
Economics 101
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 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 multi-billion dollar no-strings
attached cash infusion from their cronies in Government.
The funds required for this bailout are obtained by new taxes levied on
employed, middle-class, non-drinkers who have never been in Heidi's bar.
Now, do you understand?_______________________________________________
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