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Derivatives-Instruments of Wealth Transference & Destruction


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Derivatives-Instruments of Wealth Transference & Destruction
- by Stephen Cheesewright, Executive Director, Walter Turnbull

Published in: Business, Economy & Finance
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Derivatives-Instruments of Wealth Transference & Destruction

  1. 1. MELBOURNE SYDNEY CANBERRA Derivatives-Instruments of Wealth Transference Currency Hedging in Turbulent Times November 2003
  2. 2. Outline Introduction Why the title? Four parts to the paper – Case for the Prosecution – Case for the Defence – Effective use of Derivatives – Policy and Procedural Safeguards
  3. 3. The Case for the Prosecution Derivatives – Why do they evoke such an emotional response? Derivatives and Tulips Warren Buffet and the Time Bomb – Dominoes – Failure of Diversification – Lack of Diversity of Views
  4. 4. The Case for the Prosecution Warren’s concerns which affect you – Hell – easy to get into, hard to get out of – Mark to model? – Just what you need – A downgrade The Fable of the Wizard
  5. 5. The Case for the Prosecution Enron’s Revenues Year 2000 USDM 1999 USDM 1998 USDM Non-Derivative revenues 93,557 34,774 27,215 Non-Derivative expenses 94,517 34,761 26,381 Non-Derivative gross margins (960) 13 834 Gains (loss) from derivatives 7,232 5,338 4,045 Other expense (4,319) (4,549) (3,501) Operating income 1,953 802 1,378
  6. 6. The Case for the Prosecution Enron - The Opacity of Derivatives - Creation of Revenue - ‘Raptor’ - LJM2
  7. 7. The Case For The Defence Enron – An accounting or derivatives ‘abuse’? The ‘Benefits’ of Hindsight So you think you can avoid using derivatives??
  8. 8. Effective Use of Derivatives International Trade - Locking in estimated profit - Decision making with a foundation Managing Translation Risks Accessing offshore capital markets Separating the borrowing and hedging decision
  9. 9. Policy and Procedural Safeguards Policy - Have one - Approved by the Board - Make it specific Using particular financial instruments - Have a sound rationale There is no ‘free lunch’ and there are no zero cost options
  10. 10. Policy and Procedural Safeguards Employ the ‘KISS’ Principal Think hard before you sell an option (unless you are a bank) Back up Systems AND People Invest in Procedures – They are your safety net