428 Planning and Forecasting Ask in Capital Management Between February and April 1994, David Askin lost all $600 million that he managed on behalf of the investors in his Granite Hedge Funds. Imagine the surprise of the investors. Not only had they earned over 22% the previous year, but the fund was invested in mortgage-backed securities—instruments guaran- teed by the U.S. government not to default. The lesson from the Askin experi- ence, is that in the age of derivatives, investments with innocuous names might not be as safe and secure as they sound. The particular type of mortgage-backed securities that Askin purchased were collateralized mortgage obligations (CMOs), which are bonds whose cash flows to investors are determined by a formula. The formula is a function of mortgage interest rates and also of the prepayment behavior of home buy- ers. Since the cash flow to CMOs is a function of some other economic vari- able, interest rates in this case, these instruments are categorized as derivatives. Some CMOs rise in value as interest rates rise, others fall. Askin’s CMOs were very sensitive to interest rates. Askin’s portfolio rose in value as interest rates fell in 1993. When interest rates began to rise again in February 1994, his portfolio suffered. Interest rate increases alone, however, were not the sole cause of Askin’s losses. As interest rates rose and CMO prices fell, CMO investors everywhere got scared and sold. CMO prices were doubly bat- tered as the demand dried up. It was a classic panic. Prices fell far more than the theoretical pricing models predicted. Eventually, calm returned to the market, investors trickled back, and prices rebounded. But it was too late for Askin. He had bought on margin, and his creditors had liquidated his fund at the market’s bottom. Orange County, California Robert Citron, treasurer of Orange County, California, in 1994, fell into the same trap that snared Procter & Gamble and David Askin. He speculated that interest rates would remain low. The best economic forecasts at the time sup- ported this outlook. Derivatives allowed speculators to bet on the most likely scenario. Small bets provided modest returns. Big bets promised sizable re- turns. What these speculators did was akin to selling earthquake insurance in New York City. The likelihood of an earthquake there is very small, so insurers would almost certainly get to keep the modest premiums without having to pay out any claims. If an earthquake did hit New York, however, the losses to the insurers would be enormous. Citron bet and lost. The earthquake that toppled his portfolio was the un- expected interest rate hikes beginning in February 1994. Citron had borrowed against the bonds Orange County owned, and he invested the proceeds in deriv- ative bonds called inverse-floaters, whose cash flow formulas made them extra sensitive to interest rate increases. Citron lost about $2 billion of the $7.7 billion he managed, and Orange County filed for bankruptcy in December 1994. Financial Management of Risks 429 Union Bank of Switzerland What happened at Union Bank of Switzerland (UBS) in 1997 would be funny if it weren’t so sad. Imagine a bakery that sells cakes and cookies for less than the cost of the ingredients. Business would no doubt be brisk, but eventually the bakers would discover that they were not turning a profit. This is essen- tially what happened to UBS. UBS manufactured and sold derivatives to cor- porate customers. Unfortunately, there was an error in their pricing model, and they were selling the derivatives for too low a price. By the time they found the mistake, they had managed to lose over $200 million. Swiss banking officials concluded that losses sustained by the Global Equity Derivatives Business arm of UBS amounted to 625 million Swiss francs (about $428 mil- lion), but these losses stemmed not only from the pricing model error, but also from unlucky trading, an unexpected change in British tax laws, and market volatility. Some speculate that these losses forced the merger of UBS with Swiss Bank Corporation, a merger that was arranged exactly when the deriv- atives losses were discovered. Long-Term Capital Management The most surprising of the derivatives debacles is also one of the most recent. It is the saga of Long-Term Capital Management (LTCM). LTCM was a com- pany founded by John Meriwether, and joined by Myron Scholes and Robert Merton. Meriwether had a reputation for being one of the savviest traders on Wall Street. Scholes and Merton are Nobel prize laureates, famous for invent- ing the Black-Scholes option pricing model. 2 Unlike the folks at Procter & Gamble, these individuals cannot plead ignorance. They were without a doubt among the smartest players in the financial marketplace. Paradoxically, it may have been their intellectual superiority that did them in. Their overconfidence engendered a false sense of security that seduced investors, lenders, and the portfolio managers themselves into taking enormous positions. The story of LTCM is a classic Greek tragedy set on modern Wall Street. LTCM was organized as a “hedge fund.” A hedge fund is a limited part- nership, that in exchange for limiting the number and type of investors who can buy in, is not required to register with the Securities and Exchange Commis- sion, and is not bound by the same regulations and reporting standards imposed on traditional mutual funds. Investors must be rich. A hedge fund can accept investments from no more than 500 investors who each have net worth of at least $5 million, or no more than 99 investors if they each have net worth of at least $1 million. A hedge fund is essentially a private investment club, unfet- te red by the rules designed to protect the general public. Ironically, hedge funds are generally unhedged. Most hedge funds spec- ulate, aiming to capture profits by taking risks. LTCM was a little different, and for them the moniker “hedge fund” appeared to fit. Capitalizing on their brainpower, LTCM sought to exploit market inefficiencies. That is, with an 430 Planning and Forecasting understanding of what the prices of various financial instruments should be, LTCM would identify instruments that were priced too high or too low. Once such an opportunity was identified, they would buy or sell accordingly, hedg- ing long positions with matching shorts. As the prices in the financial market- place trended toward the fair equilibrium dictated by the financial models, the prices of the assets held long would rise, and the prices of the instru- ments sold short would fall, thereby delivering to LTCM a handsome profit. LTCM’s deals were generally not naked speculation, but hedged exploitation of arbitrage opportunities. With price risk thought to be hedged out, LTCM and their investors felt comfortable borrowing heavily to lever up the impact of the trades on profits. The creditors, banks and brokerages mostly, happily obliged. LTCM opened its doors in 1994, with an initial equity investment of $150 million from the founding partners, and an investment pool of $1.25 billion in client accounts. Success was immediate and pronounced. They thrived in the tumultuous market of the mid-1990s. Apparently, as some of the institutions described above lost fortunes during this period, it was LTCM that managed to be on the receiving end. The fund booked a 28% return in 1994, a whopping 59% in 1995, followed by another 57% return in 1996. Word of this success spread, and new investors were clamoring to get into LTCM. 3 LTCM could be picky when it came to choosing investors. This was not a fund for your typical dentist or millionaire next door. Former students of mine who have gone on to jobs at some of the world’s largest banks and investment companies have confided to me that their firms subcontracted sizable portions of their portfolios to LTCM. By the end of 1995, bolstered by reinvested prof- its and by newly invested funds, LTCM managed $3.6 billion of invested funds. However, the portfolio was levered 28 to 1. For every $1 a client invested, the fund was able to borrow $28 from banks and brokerage houses. Consequently, LTCM managed positions worth over $100 billion. Moreover, because of the natural leverage inherent in the derivatives they bought, these positions were comparable to investments of a much larger magnitude, estimated to be in the $650 billion range. By 1997, however, when the fund’s capital base peaked at $7 billion, managers realized that profitable arbitrage opportunities were growing scarce. The easy pickings of the early days were over. The partners began to intention- ally shrink the fund by returning money to investors, essentially forcing them out. Performance was sound in 1997, a 25% return, but with the payout of cap- ital, the fund’s capital base fell to $4.7 billion. Things unraveled disastrously in 1998. Each of LTCM’s major invest- ment strategies failed. Based on sophisticated models and historical data, LTCM gambled that (1) stock market volatility would stay the same or fall, (2) swap spreads—a variable used to determine who pays whom how much in interest rate swaps, would narrow, (3) the spread of the interest rate on medium-term bonds over long-term bonds would flatten out, (4) the credit Financial Management of Risks 431 spread—the inter est rate differential between risky bonds and high-grade bonds, would narrow, and (5) calm would return to the financial markets of Russia and other emerging markets. However, in each case the opposite hap- pened. Equity volatility increased. Swap spreads widened. The yield curve re- tained its hump. Credit spreads grew. Emerging markets deteriorated. Though LTCM had spread its bets over a wide variety of positions, they seemed to gain no diversification benefit. Everything went wrong at once. Re- cent research has shown that diversification does not protect speculative posi- tions when markets behave erratically. Markets tend to go awry in tandem. In August 1998 alone, the fund suffered losses of $1.9 billion. Losses for the year so far were 52%. Fund managers were confident that their strategies were sound, and that time would both prove them right and reward their pre- science. But time is not a friend to a levered fund losing money. Banks and bro- kerages itched for their loans back. How ironic, Long-Term Capital Management faced a short-term liquidity crunch. Leverage amplified LTCM’s remaining $2.28 billion of equity into man- aged assets of $125 billion. If the market continued to move against them, LTCM would be wiped out in short order, and that is essentially what hap- pened. On September 10, LTCM lost $145 million. The next day, they lost $120 million. The following three trading days brought losses of $55 million, $87 million, and $122 million, respectively. On one day alone, Monday, September 21, 1998, LTCM lost $553 million. By now traders at other firms could guess what LTCM’s positions were, and by anticipating what LTCM would have to eventually sell, they could gauge which securities were good bets to short. This selling pressure added to LTCM’s losses and woes. At this point, in September 1998, any of several banks could bankrupt LTCM by calling in its loans. The Federal Reserve, which is the central bank of the United States, and is responsible for guarantying the stability of the Amer- ican banking system, monitored the predicament. Though LTCM’s equity was shrinking precipitously, on account of their borrowed funds and the inherent leverage of their derivatives positions, the notional principal of their positions was about $1.4 trillion. To put this quantity into perspective, the gross national product of the United States was about $8.8 trillion in 1998. Total bank assets in the United States stood at $4.3 trillion. It was feared that if LTCM went bankrupt, they would probably default on their derivative positions, triggering a domino effect of defaults and bankruptcies throughout the world’s financial markets. It was decided, that LTCM was too big too fail. The Federal Reserve orchestrated a plan for LTCM’s creditors to buy the company’s portfolio. Each of 14 banks ponied up money in exchange for a slice of the portfolio. The $3.65 billion paid by the bank syndicate for the portfolio was clearly greater than the value of the portfolio by then, but this infusion of capital prevented defaults that would have cost the banks much more. The money was used to pay off debts and shore up the trading accounts so that ex- isting positions would perform without default. Very little was left over for the 432 Planning and Forecasting original partners who were required to run the fund until it was ultimately liq- uidated in 1999. The bottom line is that LTCM had lost $4.5 billion since the start of 1998. These losses included the personal fortunes amassed so quickly by the founding partners, which totaled $1.9 billion at one point but were com- pletely wiped out by the end. Moral of the Story The lesson from these case studies should now be obvious. Risk management is not the art of picking good bets. Bets no matter how good are speculation. Speculation increases risk, and subjects corporations, investors, and even mu- nicipalities to potential losses. Derivatives are powerful tools to shed risk, but they can also be used to take on risk. The root causes of the debacles described in these cases are greed, speculation, and in some cases incompetence, not de- rivatives. But just as derivatives facilitate risk management, they facilitate greed and speculation. Anything that can be done with derivatives, can be done slower the old fashioned way with positions in traditional financial instru- ments. Speculators have always managed to lose large sums. With the aid of de- rivatives they now can lose larger sums faster. Superior intellect and sophistication cannot protect the speculator. As the Long-Term Capital Management story illustrates, when you are smarter than the market, you can go broke waiting for the market to wise up. Government regulation is not the answer either. The benefits of regula- tion must be weighed against the costs. Derivatives, properly used, are too im- portant in the modern financial marketplace to be severely restricted. Abuse by a few does not warrant constraints on all users. A better solution to prevent repetition of the past debacles is full information disclosure by firms, portfolio managers, and municipalities. Investors and citizens should demand to know how derivatives are being used when their money is at stake. Better informa- tion and oversight is the most promising approach to prevent misuse of deriva- tives while retaining the benefits. Derivatives can be dangerous, but they can also be tremendously useful. Dynamite is an appropriate analogy. Misused, it is destructive; handled with care, it is a powerful and constructive tool. Derivatives are tools that facilitate the transfer of risk. Interest rate de- rivatives enable managers to shed business exposure to interest rate fluctua- tions, for example. But when one party sheds risk, another party necessarily must take on that very exposure. And therein lies the danger of derivatives. The same instrument that serves as a hedge to one firm, might be a destabiliz- ing speculative instrument to another. Without a proper understanding of de- rivatives, a manager who intends to reduce risk, might inadvertently increase it. This chapter aims to provide the reader with a basic understanding of deriv- atives so that they can be used appropriately to manage financial risks. This un- derstanding should help the reader avoid the common pitfalls that have proved disastrous to less informed managers. Financial Management of Risks 433 SIZE OF THE DERIVATIVE MARKET AND WIDESPREAD USE A derivative is a financial instrument whose value or contingent cash flows de- pend on the value of some other underlying asset. For example, the value of a stock option depends on the value of the underlying stock. Derivatives as a class comprise forwards, futures, options, and swaps. Numerous hybrid instru- ments, combining the features of these basic building blocks have also been engineered. The first thing the interested manager must understand about de- rivatives is that the business in these instruments is now huge, and their use is pervasive. Since the initiation of trading in the first stock index futures con- tract in December of 1982—the Standard & Poor’s 500 futures contract—the daily volume of stock index futures has grown so that it now rivals the daily volume in all trading on the New York Stock Exchange. (Volume of futures is measured in terms of notional principal, which is a measure of exposure.) On just one typical day in the 1990s, Tuesday, January 21, 1996, the notional vol- ume of the Standard & Poor’s 500 futures contract was just shy of $40 billion. The volume on the NYSE that same day was approximately $23 billion. On that day, therefore, just one specific futures contract was greater than the entire Big Board stock market in terms of trading volume. More recently, however, the tables have turned, and the New York Stock Exchange daily trading volume once again regularly beats that of the S&P 500 futures contract. Still the mag- nitudes are comparable, and futures trading is firmly established as a signifi- cant segment of financial market activity. Similarly, the swaps market has revolutionized banking and finance. The notional principal of outstanding swaps today, is greater than the sum total of all assets in banks worldwide. The Bank for International Settlements reports that the sum total of all assets in banks around the world was approximately $12 trillion in June 2000. At that same time, according to the same source, the notional principal of outstanding swaps was over $50 trillion. Measured this way, the swaps business is now bigger than traditional banking. The volume of the derivatives market reflects how widespread deriva- tives use has become in business. Almost all major corporations now use them in one form or another. Some use derivatives to hedge commodity price risks. Some use them to speculate on price movements. Some firms reduce their ex- posures to volatile interest rates and foreign exchange. Other firms take on exposures via derivatives in order to potentially increase profits. Some firms use derivatives to secure cheaper financing. Many corporations use derivatives to reduce the transaction costs associated with managing a pension fund, bor- rowing money, or budgeting cash. Some firms implement derivative strategies to reduce their tax burdens. Many companies offer stock options, a derivative, as employee compensation. Some investment funds enhance returns by replac- ing traditional portfolios with what are called synthetic portfolios—portfolios composed in part of derivatives. Some investment funds buy derivatives that act as insurance contracts, protecting portfolio value. Since their emergence in 434 Planning and Forecasting the early 1980s, derivatives have touched every aspect of corporate finance, banking, the investments industry, and arguably business in general. THE INSTRUMENTS The major derivative instruments are forwards, futures, options, and swaps. Also available today are hybrid instruments, exotics, and structured or engi- neered instruments. The hybrids, exotics, and engineered instruments are con- tracts that combine features of the basic building blocks: the options, futures, forwards, and swaps. Consequently, familiarity with the basic building blocks goes a long way toward understanding the whole mélange of derivative instru- ments available today. We will begin with forwards. For wards Imagine the following nearly idyllic scenario. It is late summer. You are a wheat farmer in Kansas. The hard work of sowing and tending your acreage is about to pay off. You expect a bumper crop this year, and the harvest is just a few weeks away. The weather is expected to remain favorable. The crops have been sprayed to protect them from pests. In fact, you may even have purchased crop insurance to protect against crop damage. Still, you cannot relax. One major uncertainty is keeping you awake at night. You figure that if you are expecting a bumper crop, the likelihood that your neighbors are also expecting a bumper crop is high. If the market is flooded with wheat, prices will plummet. If prices drop, you will receive little revenue for your harvest, and perhaps you will show a loss for the year. A worse case scenario might be that prices fall so low, that you cannot make the mort- gage payments on your land or the machinery you bought. You very well might lose the farm—and through no fault of your own. You farmed well, but if prices fall, you will fail nevertheless. Meanwhile, at the same time, another group of businesspeople is feeling similar anxiety. A baked goods company has recently built a new cookie bak- ery. The company identified its market niche as a provider of inexpensive, mass produced, medium quality cookies. The project analysis that led to the go-ahead for the new bakery assumed that wheat prices would stay fixed at their current levels. If wheat prices should rise, it is altogether possible that the firm will not be able to sell its cookies for a profit. The new bakery will appear to be a failure. In these scenarios, both the farmers and the bakers are exposed to wheat price risk. The farmers worry that wheat prices will fall. The bakers worry that prices will rise. A forward contract is the obvious solution for both parties. The farmers and bakers can negotiate a deferred wheat transaction. The farmers will deliver wheat to the bakers, one month from now, for a price cur- rently agreed upon. Such a contract for a deferred transaction is a forward Financial Management of Risks 435 con tract. A forward contract specifies an underlying asset to be delivered, a price to be paid, and the date of delivery. The specified transaction price is called the forward price. The party that will be selling wheat (the farmer) is known as the “short” party; the party that will be buying wheat (the baker) is known as the “long” party. In the jargon of the derivatives market, the long party is said to “buy” the forward, and the short party “sells” the forward. Note, however, that when the deal is initially struck, no money changes hands and no one has yet bought or sold anything. The “buyer” and “seller” have agreed to a deferred transaction. Notice that the wheat forward reduces risk for both the farmers and the bakers. In this transaction, both parties are hedgers—that is, they are using the forward to reduce risk. Forward contracts are “over-the-counter” instru- ments, meaning that they are negotiated between two parties and custom- tailored, rather than traded on exchanges. Suppose after one month, when the forward expires and the wheat is deliv- ered, the current, or spot, price of wheat has risen dramatically. The farmer may have some regret that he entered into the contract. Had he not sold forward, he would have been able to receive more for his wheat by selling on the spot mar- ket. He may feel like a loser. The bakers, on the other hand, will feel like win- ners. By contracting forward they insulated themselves from the rising wheat price. When spot prices rise, the long party wins while the short party loses. A little reflection, however, will convince the farmer that although he lost some money relative to what he could have gotten on the spot market, going short in the forward was indeed a worthwhile strategy. He had piece of mind over the one month. He was guaranteed a fair price, and he did not have to fear losing the farm. Though there was an opportunity loss, he benefited by shedding risk. The farmer probably never regrets that he has never collected on his life insurance either. He similarly should not regret that the forward contract represents an op- portunity loss. He would be well advised to go short again next year. The wheat forward contract can be used by speculators as well as hedgers. An agent who anticipates a rise in wheat prices can profit from that foresight by going long in the forward contract. By going long in the contract, the speculator agrees to buy wheat at the fixed forward price. Upon expiration of the contract, the speculator takes delivery of the wheat, pays the forward price, and then sells the wheat on the spot market for the higher spot price. The profit is the difference between the spot and forward prices. Of course, if the speculator’s forecast is wrong, and the wheat price falls, the speculator would suffer losses equal to the difference between the forward and spot price. For example, suppose the initial spot price is $3 per bushel, and the for- ward price is $3.50 per bushel. If the spot price upon expiration is $4.50 per bushel, the long speculator would earn a profit of $1 per bushel. The profit is the terminal spot of $4.50 minus the $3.50 initial forward price. If, alterna- tively, the terminal spot price is $3.25, the speculator would lose 25 cents per bushel—that is, $3.25 minus $3.50. Notice that the $3 initial spot price is irrel- evant in both cases. 436 Planning and Forecasting Speculators play important roles in the derivatives markets. For one, speculators provide liquidity. If farmers wish to short forward contracts but there are no bakers around who want to go long, speculators will step in and offer to take the long side when the forward price is bid down low enough. Similarly, they will take the short side when the forward price is bid up high enough. Speculators also bring information to the marketplace. The existence of derivatives contracts and the promise of speculative profits make it worth- while for speculators to devote resources to forecasting weather conditions, crop yields, and other factors that impact prices. Their forecasts are made known to the public as they buy or sell futures and forwards. Futures Futures contracts are closely related to forward contracts. Like forwards, futures are contracts that spell out deferred transactions. The long party commits to buying some underlying asset, and the short party commits to sell. The differences between futures and forwards are mainly technical and logistical. Forward contracts are custom-tailored, over-the-counter agree- ments, struck between two parties via negotiation. Futures, alternatively, are standardized contracts that are traded on exchanges, between parties who probably do not know each other. The exact quantity, quality, and delivery location can be negotiated in a forward contract, but in a futures contract the terms are dictated by the exchange. Because of their standardization and how they are traded, futures are very liquid, and their associated transaction costs are very low. Another feature differentiating futures from forwards is the process of marking-to-market. All day and every day, futures traders meet in trading pits at the exchanges and cry out orders to buy and sell futures on behalf of clients. The forces of supply and demand determine whether futures prices rise or fall. Marking-to-market is the process by which at the end of each day, losers pay winners an amount equal to the movement of the futures price that day. For ex- ample, if the wheat futures price at Monday’s close is $4.00 per bushel, and the price rises to $4.10 by the close on Tuesday, the short party must pay the long party 10 cents per bushel after trading ends on Tuesday. If the price had fallen 10 cents, then long would pay short 10 cents per bushel. Both long and short parties have trading accounts at the exchange clearinghouse, and the transfer of funds is automatic. The purpose of marking-to-market is to reduce the chance of default by a party who has lost substantially on a futures position. When futures are marked-to-market, the greatest possible loss due to a default would be an amount equal to one day’s price movement. Futures are marked-to-market every day. When the contract expires, the last marking-to-market is based on the spot price. For example, suppose two days prior to expiration the futures price is $4.10 per bushel. On the second to last day the futures price has risen to $4.30. Short pays long 20 cents per bushel. Suppose at the end of the next day, the last day of trading, the spot Financial Management of Risks 437 price is recorded at $4.55. The last mark-to-market payment is from short to long for 25 cents per bushel, equal to the difference between the spot price upon expiration and the previous day’s futures price. Upon expiration, the futures contract might stipulate that the short party now deliver to the long party the specified quantity of wheat. The long party must now pay the short party the spot price for this wheat. Yes, the spot price, not the original futures price! The difference between the terminal spot price and the original futures price has already been paid via marking-to-market. A numerical example will make the mechanics of futures clearer, and show how similar futures are to forwards. Suppose with five days remaining until expiration, the wheat futures price is $4.00 per bushel. A baker “buys” a futures contract in order to lock in a purchase price of $4.00. Suppose the futures prices on the next four days are $4.10, $3.90, $4.00, and $4.25. The spot price on the fifth day, the expiration day, is $4.30. Given those price movements, short pays the long baker 10 cents the first day. The long baker pays short 20 cents on the second day. On the third day, short pays long 10 cents, followed by a payment from short to long of 25 cents on the fourth day, and a payment from short to long of 5 cents on the last day. On net, over those five days, short has paid long 30 cents. When long now pays the spot price of $4.30 to short for delivery of the wheat, long indeed is paying $4.00 per bushel, net of the 30 cents profit on the futures contract. Recall that $4.00 was the original futures price. Thus, the futures contract did effectively lock in a fixed purchase price for the wheat. A contract that stipulates a spot transaction in which the underlying com- modity is actually delivered at expiration, is called a “physical delivery” con- tract. Many futures contracts do not stipulate such a final spot transaction with actual delivery of the underlying asset. After the last marking-to-market, the game is over. No assets are delivered. Contracts that stipulate no terminal spot transaction are called “cash settled.” It should make little difference to traders whether a contract is cash settled or physical delivery. A cash settled contract can be turned into a physical delivery deal simply by choosing to make a spot transaction at the end. Likewise, a physical delivery contract can be turned into a cash settled deal by either making an offsetting spot transaction at the end, or by exiting the futures contract just before it expires. Examples of the Use of Forwards and Futures in Risk Management A wide variety of underlying assets is covered by futures and forwards con- tracts these days. For example, exchange-traded futures contracts are available on stocks, bonds, interest rates, foreign currencies, oil, gasoline, grains, live- stock, metals, cocoa, coffee, sugar, and even orange juice. Consequently, these instruments are versatile risk management tools in a wide variety of situations. The most actively traded futures, however, are those that cover financial risks. Consider the following examples. . stipulate that the short party now deliver to the long party the specified quantity of wheat. The long party must now pay the short party the spot price for this wheat. Yes, the spot price, not the. the forward price. The party that will be selling wheat (the farmer) is known as the “short” party; the party that will be buying wheat (the baker) is known as the “long” party. In the jargon. pays the forward price, and then sells the wheat on the spot market for the higher spot price. The profit is the difference between the spot and forward prices. Of course, if the speculator’s forecast