Traders, Guns, & Money by Satyajit Das
Traders, Guns, & Money by Satyajit Das
Das has written a bunch of the "big" books for swaps, CDOs, and derivatives of the ilk. Here, he uses his decades of explaining complex financial structures to provide us with a quick overview of derivatives as seen in the wild, which involves lots of deals exploding in people's faces. Happily, he works through the mechanics of deals (some equations, whoa! ;).
In Chapter 1, A derivative idea, Das tries to explain basic derivatives using a farm. It can be made better.
Say you have a wheat farm, every year you worry about two things: your crop failing and what price it will bring when you take it to the market. In the US, you can buy crop-fail insurance, which guarantees you payment should your crop fail. You can also buy price insurance, by buying the right to sell wheat to someone at a price you negotiate in the spring (a put option).Anything that derives from a sale or a loan of wheat (like the right to do so) by definition must have a derivative in it. Lots of previously thought well-understood financial products contain derivative rights that can now be stripped out and sold.
Finally, this book puts quotes from the surrounding text inline with a different 50% bigger font. Just put an executive summary in the front of the book for the non-readers.
There is a tide in the affairs of men, Which, taken at the flood, leads on to fortune; Omitted, all the voyage of their life Is bound in shallows and in miseries. (Brutus goes on to lose at Philippi ;)
The essence of the advice (sell high-percentage win first, then junk second) was remarkably accurate. The clients I had dealt with fell for the trick every time. They put on a trade. They made money. Then, they kept coming back for more. Even if they lost money, they kept coming back. Nero (sales guy) was a reasonable judge of human nature.
I remembered an undoubtedly apocryphal lawyer's story. The accused in a crimainal matter is most impressed by his lawyer's blistering cross-examination of the police witness. 'We are doing great,' the accused says to his lawyer. 'I am doing great,' the lawyer snaps back. 'You are going down for 20 years.'
Volcker (Paul Volcker, Fed Chairman) had embarked on an unpopular strategy of high interest rates that had ultimately proved successful in beating inflation, although there had been collateral damage. The entire US Savings and Load Industry had ended up as road-kill. (while banks and other bank-likes survived, perhaps due to having more rational people)
The business in the early 1980s was a curious mix of corporate finance, new issues and trading. We arranged back-to-back transactions with limited need for hedging or risk management; pricing and hedging models were primitive by modern standards; mastery of a Hewlett-Packard 12C (a handheld financial calculator) qualified you as a rocket scientist.
Our tax lawyer, a 50-something woman from teh most expensive law firm in town, was my role model. On her wall was a framed excerpt from a judgment in a case concerning a clause that she had drafted. The judge had commented that he had found the clause to be of 'stupefying legal density beyond human comprehension'.
The first hurdle was to find the right person for each client. One bank's most problematic client was a Japanese pension fund manager. He was a small, balding 60-something man who managed assets sufficient to buy the rest of Asia, leaving change. The bank had courted him ceaselessly for years, to no avail. It turned out the fund manager had a weakness -- a cliched partiality for very tall, long-legged, blue-eyed, blonde women...
A global search ws undertaken and the human resources department performed admirably... She (stereotypical Scandinavian) was bright, pleasant and efficient, but there was one problem -- she had no knowledge of derivatives... The bank hired her anyways, figuring, correctly it turned out, that the fund manager wasn't that interested in her derivatives. Over the next few months, the fund became one of the bank's largest Japanese accounts.
Traders argued that showing clients a good trade idea was crazy. If it was that good then they should put the trade on for the firm's own account. Why turn a client into a competitor? 'Who the f*** do you work for -- us or them?' This was the frequent barb hurled by traders at salespeople. They competed to get ideas from research staff. (I expect they now have an expected value for giving a trade to a client, how much junk can they sell them afterwards.)
What they (market commentators) said was unimportant, it was only important that they were seen and their employers were in the public domain constantly. My economics lecturer went on to a new career, becoming the chief economist of a bank. In a moment of rare candour, he mused whether he should join the entertainment trade union, reflecting on his role as the media face of the bank.
- Diversification. Let's do several things that we don't know anything about badly.
- Focus. Let's get back to doing what we once did if anybody can remember what it is and how to do it.
- Decentralization. Massive duplication, confusion and creation of thousands of petty empires.
- Matrix structures. Everybody reports to everybody, no one knows who they work for and there is no accountability.
- Flat organizations. Managers who can't manage now manage tens of direct reports.
- Business process reorganization. A process by which you cut everything that is essential, leaving only everything you don't need.
A Japanese securities firm stunned its management consultants by asking for a 10,000-year business plan. The securities firm had previously asked for a three-year plan and received what seemed like a one-month plan... The Japanese had concluded that Wester time scales were different. They were actually seeking a 10-year plan.
The rising casualty list resulted in a shift (from competitives sports) to psychological bonding. Tihs consisited of team-building exercises led by a trainer. In one exercise, about listening and trust, individuals were blindfolded and required to walk across a muddy obstacle course. A partner shouted guiding instructions to the blindfolded person. The results were catastrophic. I don't recall anybody making it across. Senior management proved especially bad.
Actions of distressed fish generally attract predators. The predator in this case was a famed corporate raider -- Sol Steinberg and Reliance Insurance Company. Reliance launched a hostile takeover bid for Disney and its management reacted in time-honoured fashion -- they thought about shareholders. Then, they thought about themselves. Disney bought back the Reliance shareholding, handing the raider a nice greenmail profit.
Finnish proverb: Shit must be good, millions of flies can't wrong.
People frequently spend excessive time on small decisions and an inadequate amount on larger decisions. The time taken on a decision is inversely related to the amount of money spent -- Parkinson's Law. Large expenditures, say millions of dollars on a new computer system, are approved with minimal discussion. Small expenditures, whether chocolate biscuits should be served for coffee breaks, require endless discussions. Then, there is regret. People spend an inordinate amount of time crying over spilt milk, leading to more irrational decisions.
In reality, there are four main financial risks. If you own shares and the share price falls sharply then you lose money, this is market risk. Someone fails to pay you money that you len them or fails to perform a contract (say, a derivative agreement), this is credit risk. You may be unable to sell what you own or buy back what you are short, you run out of money to fund your positions or make payments, this is liquidity risk. Operational risk is anything that inflicts losses but isn't market, credit, or liquidity. Risk professionals have spent years trying to define operational risk more precisely.