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The Derivatives Markets Explained


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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.  

And, he has an MBA to back up this analysis.  

 

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 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 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 the Government. The  

funds required for this bailout is obtained by new taxes levied on 

employed, middle-class, non-drinkers.  

 

Now, do you understand? [:-))]

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A really excellent illustration,   amplifies a similar one I saw in the French language,   but yours is more comprehensive.

Can I add this one,  which "explains" how Quantitative Easing works.  

"It is a slow day in a small Florida town and streets are deserted. Times are tough, everybody is in debt, and everybody is living on credit. A rich tourist drives through town, stops at the motel, and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs to pick one for the night.

As soon as he walks upstairs, the motel owner grabs the bill and runs next door to pay his debt to the butcher.

The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.

The pig farmer takes the $100 and heads off to pay his bill to his supplier, .the Farmer's Co-op

The guy at the Farmer's Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her "services" on credit.

The hooker rushes to the hotel and pays off her room bill with the hotel owner.

The hotel proprietor then places the $100 back on the counter so the rich traveler will not suspect anything.

At that moment the traveler comes down the stairs, states that the rooms are not satisfactory, picks up the $100 bill and leaves town.

No one produced anything. No one earned anything. However, the whole town is now out of debt and now looks to the future with a lot more optimism.

And that, ladies and gentlemen, is how the United States Government is conducting business today
"

Source:  Bob Copeland in a Telegraph comment.

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LA CRISE DES SUBPRIMES EXPLIQUEE A MA F1LLE (option sciences economiques et sociales)

Sujet : Crise des subprimes: une explication tres simple pour ceux qui essayent encore de comprendre

Alors voila, Mme. Ginette a une buvette a Bertincourt, dans le Pas de Calais. Pour augmenter ses ventes, elle decide de faire credit a ses fideles clients, tous alcooliques, presque tous au chomage de longue duree. Vu qu'elle vend a credit, Mme. Ginette voit augmenter sa frequentation et, en plus, peut augmenter un peu les prix de base du "calva" et du ballon de rouge.

Le jeune et dynamique directeur de l'agence bancaire locale, quant a lui, pense que les "ardoises" du troquet constituent, apres tout, des actifs recouvrables, et commence a faire credit a Mme. Ginette, ayant les dettes des ivrognes comme garantie.

Au siege de la banque, des traders avises transforment ces actifs recouvrables en CDO, CMO, SICAV, SAMU, OVNI, SOS et autres sigles financiers imbitables_

Ces instruments financiers servent ensuite de levier au marche et conduisent, au NYSE, a la City de Londres, aux Bourses de Francfort et de Paris, etc., a des operations de derives dont les garanties sont totalement inconnues de tous (c.a.d., les ardoises des ivrognes de Mme Ginette) mais qui permettent aux banques et aux traders de s'en foutre plein les poches en vendant du vent. .

Ces "derives" sont alors negocies pendant des annees comme s'il s'agissait de titres tres solides et serieux sur les marches financiers de 80 pays.

Jusqu'au jour ou quelqu'un se rend compte que les alcoolos du troquet de Bertincourt n'ont pas un rond pour payer leurs dettes.

La buvette de Mme. Ginette fait faillite , suivie des banques et des marches financiers .

Apologies if there are some typos,  my original version was a picture embedded into Word,  and I've used some rather odd pdf software (into which I converted the Word doc) to recover the text.

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[quote user="Martin963"]A really excellent illustration,   amplifies a similar one I saw in the French language,   but yours is more comprehensive.

Can I add this one,  which "explains" how Quantitative Easing works.  

"It is a slow day in a small Florida town and streets are deserted. Times are tough, everybody is in debt, and everybody is living on credit. A rich tourist drives through town, stops at the motel, and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs to pick one for the night.

As soon as he walks upstairs, the motel owner grabs the bill and runs next door to pay his debt to the butcher.

The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.

The pig farmer takes the $100 and heads off to pay his bill to his supplier, .the Farmer's Co-op

The guy at the Farmer's Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her "services" on credit.

The hooker rushes to the hotel and pays off her room bill with the hotel owner.

The hotel proprietor then places the $100 back on the counter so the rich traveler will not suspect anything.

At that moment the traveler comes down the stairs, states that the rooms are not satisfactory, picks up the $100 bill and leaves town.

No one produced anything. No one earned anything. However, the whole town is now out of debt and now looks to the future with a lot more optimism.

And that, ladies and gentlemen, is how the United States Government is conducting business today
"


Source:  Bob Copeland in a Telegraph comment.

[/quote]

I guess it is just as well no one owed any money to the banker and paid him,because if they did, he would have just kept the $100 as a "bonus" and the recession would have continued in this small Florida town. [Www]
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  • 4 weeks later...
[quote user="Martin963"]A really excellent illustration,   amplifies a similar one I saw in the French language,   but yours is more comprehensive.

Can I add this one,  which "explains" how Quantitative Easing works.  

"It is a slow day in a small Florida town and streets are deserted. Times are tough, everybody is in debt, and everybody is living on credit. A rich tourist drives through town, stops at the motel, and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs to pick one for the night.

As soon as he walks upstairs, the motel owner grabs the bill and runs next door to pay his debt to the butcher.

The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.

The pig farmer takes the $100 and heads off to pay his bill to his supplier, .the Farmer's Co-op

The guy at the Farmer's Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her "services" on credit.

The hooker rushes to the hotel and pays off her room bill with the hotel owner.

The hotel proprietor then places the $100 back on the counter so the rich traveler will not suspect anything.

At that moment the traveler comes down the stairs, states that the rooms are not satisfactory, picks up the $100 bill and leaves town.

No one produced anything. No one earned anything. However, the whole town is now out of debt and now looks to the future with a lot more optimism.

And that, ladies and gentlemen, is how the United States Government is conducting business today
"

Source:  Bob Copeland in a Telegraph comment.

[/quote]

Thank you for the post.

Hi guys, Im a newbie. Nice to join this forum.

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