Derivatives are blamed for starting the financial meltdown of our once dependable American economy. I figure I should learn more about these investment tools so I looked them up on Wikedpedia. Here is what we all need to know:
Derivatives are financial contracts, or financial instruments, whose values are derived from the value of something else (known as the underlying, based on the phrase; to lie). The underlying on which a derivative is based can be an asset (e.g., commodities, equities (stocks), residential mortgages, commercial real estate, loans, bonds but NOT bonuses), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation derivatives), or other items (e.g., weather conditions, the flight path of bumble bees, or other derivatives).
Credit derivatives are based on loans, bonds or other forms of credit, essentially, any worthless paper you can find near a bank.
Investors who buy Credit Derivatives are known as suckers the world is full of this type of investor. It is the Derivative salesman’s job to find these suckers and sell as many Credit Derivatives to them as possible so as to get himself a big fat bonus.
Derivatives can be used to mitigate the risk of economic loss arising from changes in the value of the underlying. This activity is known as hedging.Hedges are what you will be trimming for a living, along with your immediate supervisors, illegal aliens Paco and Ramone, after you invest your 401k in derivatives. Alternatively, derivatives can be used by investors for a very brief time to increase the temporary profit arising occasionally if the value of the underlying ever moves in the direction they expect which it never will be for long. This activity is known as reckless speculation.
Because the value of a derivative is contingent on the value of the underlying, the notional value of derivatives is recorded off the balance sheet of an institution, although the, smoke and mirrors market value of derivatives is recorded on the balance sheet, your losses will be henceforth known as off the charts.
As one can see, derivatives serve a useful and important purpose in guiding private and non-profit investments towards their ultimate destination, the pockets of derivative salesmen and takeover by grandstanding politicians who will purchase them with your tax dollars and freshly printed money which has no value.
Next week I will post a Wikedpedia article on Hyper-inflation.