Tim Lamb wrote:
In message , The Natural Philosopher
writes

Can someone kindly give me an explanation of derivatives? Preferably
in plain English:-)
I think I have grasped the principle of *short selling* and stock
lending.


First of all, forget the calculus meaning.


A derivative product is one that does not involve buying or selling
the underlying share, biond, currency etc. but a product DERIVED from it.

If you like, buting a race horse and winning a race with it, is the
normal stock market.

Placing a bet on the horse is a derivative.

So is insuring it, in fact.

Derivatives are contracts of a sort, which have value depending on the
underlying value of some actual tradeable element.


Things get confusing when you but shares in e.g. funds that trade in
derivatives..


There's an interesting bit of recursion if a company invests its funds
in derivatives of its own share price.

And in fact, to an extent, a lot of derivatives are in fact of that
sort. So there is massive potential for positive feedback.

This is why they are regarded as leading to excessive volatility -
(think high gain: they amplify small perturbations).


The essence of rogue trading, is that a large financial institution
that takes a bet on an underlying, is supposed to lay that bet off by
buying or selling the underlying, or at least selling bets the other way.

If a trader doesn't do that, he becomes a punter or a bookie with high
exposure.

Hmm.. Thanks.

I suppose horse racing bets are an accepted fact of life.

Would the world shudder to a halt if derivative trading was regulated?

Its very much a feature.

Like anything else, it has good sides and bad.

Someone I know took out currency options to protect their (dollar)
salary against a falling dollar, and made more out of those than the
salary! that was a few years back..

In particular people who trade in volatile commodities, like oil and
grain, need to be able to offset really bad years prices with some form
of insurance.

The bad press is when it pure speculation..but hey, there's nothing
wrong with betting on the horse, provided its YOUR money.

What went wrong as the banks, the high street safe as houses banks,
placing one way bets of staggering magnitude on house prices carryig on
rising, on te basis taht the more money they lent, the more the house
prices would ridse.

Not only was it not their money, they also overborrowed, and its cost us
as much again in bail out.

THAT is where regulation is needed. High street boring banks should not
be using customers deposits as place bets at the poker tables.

If they had been e.g. hedge funds, well if you stuff money in a hedge
fund, you have to expect one year in ten you will lose your shirt.

RBS and Lloyds, and so on, SHOULD have been allowed to go bust. They
should have transferred assets of quality to another high street bank,
guaranteed deposits and let the rest crash and burn. Along with their
directors and bonuses.







regards