Sunday, May 20, 2007

Derivatives, Derivatives, Derivatives......

everything is fine until........ alles in bester ordung bis......

here is just one example how many risks are hidden via John Succo / Minyanville

The credit agencies, therefore, need to compete for business based at least in part on the ratings they are willing to give these tranches. As a result, they will only downgrade when forced to by experienced losses; not rising default rates, not a worsening economy, but only actual, experienced losses.

Even more disturbing, they will be most reluctant to downgrade the riskiest tranches (the equity tranches) since those continue to be owned by the issuers even after the deal is sold.

So even though the mortgage market has deteriorated substantially, mark-to-market losses by those holding the CDO paper have generally not been realized simply because the rating agencies have not changed their ratings for all the above reasons. Accounting rules only require holders of the paper to mark prices according to the accepted model, not actual prices.

Actual prices where traders can really buy and sell is substantially lower than where investors are marking their positions. The levels at which investors are carrying the paper is not reflecting underlying reality as the holders simply hold their collective breath and the rating agencies ignore a worsening environment.......

The global derivatives market grew at the fastest pace in at least nine years during 2006 as the amount of contracts based on bonds more than doubled to $29 trillion, the Bank for International Settlements said today.

Derivatives covering bonds and loans rose by $15 trillion last year, the Basel, Switzerland-based bank said on its Web site. The total amount of over-the-counter contracts whose value is derived from price changes of bonds, currencies, commodities and stocks, or events like interest rates or the weather rose 39.5 percent to $415 trillion, the biggest jump since the BIS began compiling the data. ....

``Derivatives are now a major contributor to investment bank earnings,'' said Jerry Del Missier, co-president of Barclays Capital in London, the biggest underwriter of European bonds last year. ``Credit derivatives will continue their high growth path for a long time yet, and that growth rate will be higher than any other market.''

The actual money at risk through credit derivatives increased 93 percent to $470 billion last year, the BIS said. The amount at stake in the entire derivatives market is $9.7 trillion, according to the BIS....

Morgan Stanley, the world's second-biggest securities firm by market value, said a jump in revenue from credit products helped spur a 70 percent increase in first-quarter profit to an all-time high. Bear Stearns, the fifth-biggest U.S. securities firm, said credit derivatives trading contributed to an 8 percent increase in first-quarter profit. Deutsche Bank reported record revenue from trading debt and credit derivatives, helping lift first-quarter profit by 30 percent.

Contracts on bonds took off in the 1990s when New York-based JPMorgan Chase & Co. led banks creating credit-default swaps. The contracts allow bond investors to hedge against the risk of a company or country defaulting on interest payments or speculate on its creditworthiness.

Market Declines
Derivatives helped investors hedge their risks and contained a decline in bond prices during 2005 when the credit ratings on debt of Ford Motor Co. in Dearborn, Michigan, and Detroit-based General Motors Corp. was reduced to below investment grade. .....

``We have been through several market corrections in the past few years and in each case, markets have recovered,'' Jain said in an e-mail. ``In retrospect, people think the market has been characterized by calm, continuous and even benign conditions. Derivatives are a big part of explaining that phenomenon.''

Interest-Rate Swaps
Banks and hedge funds say it's cheaper and easier to use credit-default swaps than buying or selling the underlying securities. Investors who buy the contracts are paid the face value of the underlying debt in exchange for the defaulted notes should the company fail to adhere to debt agreements.

Interest-rate swaps remain the biggest part of the derivatives market, growing 15 percent to $292 trillion, compared with 38-percent growth the previous year, the report said. The contracts allow companies to switch between fixed-rate and floating-rate interest payments.

Growth in the overall derivatives market outpaced the previous record increase of 39.2 percent in 2003.

Foreign-exchange derivatives rose 28 percent to $40.2 billion in 2006. Contracts based on commodities such as gold and oil expanded by 27.7 percent to $6.9 trillion.
The BIS surveyed 62 institutions for its semi-annual report.
The outstanding amounts of derivatives ($ trillion).
End-Dec 2006 End-June 2006 End-Dec 2005
Interest rates 292 262 212
Credit 29 20 14
Equity 7.5 6.8 5.8
Commodities 6.9 6.4 5.4
Foreign Exchange 40 38 31
by the way.....this was a filing from GE...makes you feel better when a aaa rated company isnĀ“t able to book things correctly.......
es sollte ebnfalls zu denken geben wenn weltklassefirmen wie GE nicht in der lage sind diese wundermittel der finanzinnovation korrekt zu verbuchen......
We identified the following material weakness in our internal control over financial reporting - we did not have adequately designed procedures to designate each hedged commercial paper transaction

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