An Easily Understandable Explanation of Derivative Markets

An Easily Understandable Explanation of Derivative Markets

Economics 101

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, I understand

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An Easily Understandable Explanation of Derivative Markets Economics 101 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…
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