das - traders, guns & money; knowns and unknowns in the dazzling world of derivatives (2006)

KNOWNS AND UNKNOWNS IN THE DAZZLING WORLD OF DERIVATIVES SATYAJIT DAS Visit our website at www.pearson-books.com Cover by Heat design An imprint of Pearson Education BUSINESS SATYAJIT DAS “Make฀room฀for฀another฀must-read฀on฀the฀shelves฀฀ of฀any฀City฀or฀Wall฀Street฀trader,฀salesman,฀or฀victim.฀฀ Traders,฀Guns฀&฀Money฀is฀filled฀with฀dirty฀little฀ secrets,฀some฀old฀and฀some฀new.฀Anyone฀who฀฀ has฀worked฀on฀a฀trading฀floor฀will฀nod฀and฀laugh.฀ Those฀who฀have฀not฀will฀shake฀their฀heads฀and฀cry.฀ When฀‘derivatives’฀and฀‘f******’฀appear฀together฀฀ on฀every฀other฀page,฀you฀know฀someone฀has฀written฀ the฀truth฀about฀financial฀innovation.฀Be฀afraid.”฀ Frank฀Partnoy,฀author฀of฀FIASCO฀and฀Infectious฀ Greed฀and฀Professor฀of฀Law฀at฀the฀University฀of฀฀ San฀Diego “Very,฀very฀real.฀Risk฀management฀at฀the฀front฀line,฀฀ and฀unlike฀anything฀you’ll฀have฀seen฀in฀the฀textbooks.”฀ ฀ Paul฀Wilmott,฀writer,฀mathematician฀and฀author฀of฀฀ the฀quantitative฀finance฀website฀www.wilmott.com Warren฀Buffet฀once฀memorably฀described฀derivatives฀฀ as฀“financial฀weapons฀of฀mass฀destruction”.฀Read฀this฀ sensational฀and฀controversial฀account฀of฀the฀often฀ dazzling฀business฀of฀derivatives฀trading,฀and฀see฀if฀฀ you฀agree. No฀money฀is฀ever฀really฀made฀in฀financial฀markets.฀ Markets฀merely฀transfer฀wealth.฀As฀to฀how฀to฀make฀ money?฀Well,฀it฀is฀basically฀theft,฀misrepresentation,฀lies,฀ cheating,฀deception฀or฀force.฀It฀is฀impossible฀to฀make฀ the฀staggering฀amounts฀made฀in฀derivatives฀in฀good฀฀ years฀honestly. Traders,฀Guns฀&฀Money฀is฀a฀wry฀and฀wickedly฀comic฀ exposé฀of฀the฀culture,฀games,฀and฀pure฀deceptions฀ played฀out฀every฀day฀in฀trading฀rooms฀around฀the฀world,฀ usually฀with฀other฀people’s฀money.฀Whether฀you฀move฀฀ in฀the฀financial฀world฀yourself,฀know฀people฀who฀do,฀or฀ have฀money฀invested฀in฀stocks,฀shares฀or฀derivatives,฀ this฀is฀a฀fascinating฀read฀guaranteed฀to฀make฀you฀think.฀ “I฀had฀been฀in฀derivatives฀for฀over฀25฀years.฀฀ Many฀traders฀hadn’t฀been฀born฀when฀I฀ stumbled฀accidentally฀into฀the฀arcane฀world฀ of฀derivatives฀trading.฀How฀did฀I฀get฀there?฀฀ I฀had฀followed฀the฀money.฀I฀had฀ridden฀the฀ tide฀and฀currents฀of฀financial฀markets.฀I฀had฀ not฀known฀very฀much฀then.฀Even฀now฀I฀only฀ knew฀the฀many฀unknowns.฀How฀did฀I฀get฀ here?฀It฀was฀a฀very฀long฀story.฀Traders,฀Guns฀ &฀Money฀is฀that฀story…” Satyajit฀Das฀is฀an฀international฀expert฀in฀the฀ dazzling฀world฀of฀financial฀derivatives฀and฀has฀ 25฀years’฀experience฀in฀the฀financial฀markets.฀ He฀has฀had฀a฀foot฀on฀both฀sides฀of฀the฀ derivatives฀equation,฀having฀worked฀for฀banks฀ (the฀“sell฀side”)฀such฀as฀the฀Commonwealth฀ Bank฀of฀Australia,฀Citicorp฀Investment฀Bank฀฀ and฀Merrill฀Lynch฀and,฀as฀Treasurer฀of฀the฀TNT฀ Group,฀for฀clients฀(the฀“buy฀side”).฀He฀now฀acts฀ as฀a฀consultant฀advising฀banks฀and฀corporations฀ and฀presenting฀seminars฀throughout฀the฀world฀ on฀the฀slippery฀subject฀of฀derivatives. Das฀is฀the฀author฀of฀a฀number฀of฀highly฀฀ regarded฀standard฀reference฀books฀on฀ derivatives฀including฀Swaps/Financial฀ Derivatives฀(2004,฀Wiley),฀Structured฀Products฀฀ &฀Hybrid฀Securities฀(2001,฀Wiley)฀and฀Credit฀ Derivatives,฀CDOs฀and฀Structured฀Credit฀ Products฀(2005,฀Wiley).฀Outside฀the฀wild฀world฀ of฀derivatives,฀Das฀is฀passionate฀about฀real฀ wildlife฀and฀is฀co-author฀(with฀Jade฀Novakovic)฀ of฀In฀Search฀of฀the฀Pangolin:฀The฀Accidental฀฀ Eco-Tourist฀(2006,฀New฀Holland),฀a฀unique฀฀ travel฀narrative฀focused฀on฀eco-tourism.฀ TELLS฀A฀CRACKING฀STORY,฀ AND฀IN฀DOING฀SO฀REVEALS฀ BOTH฀THE฀HARD฀FACTS฀AND฀ THE฀SOFT฀UNDERBELLY฀OF฀ THE฀WORLD฀OF฀DERIVATIVES ฀“IN฀MOST฀BUSINESSES,฀THE฀NATURE฀ OF฀THE฀PRODUCT฀IS฀A฀KNOWN฀ KNOWN.฀WE฀DO฀NOT฀SPEND฀A฀LOT฀ OF฀TIME฀DEBATING฀THE฀USE฀OF฀OR฀ OUR฀NEED฀FOR฀A฀PAIR฀OF฀SHOES.฀ WE฀ALSO฀UNDERSTAND฀OUR฀ CHOICES฀–฀LACE฀UP฀OR฀SLIP-ON,฀ BLACK฀OR฀BROWN.฀I฀SPEAK,฀฀ OF฀COURSE,฀OF฀MEN’S฀SHOES฀฀ HERE.฀WOMEN’S฀SHOES,฀WELL,฀ THEY฀ARE฀CLOSER฀TO฀DERIVATIVES.฀ THE฀DERIVATIVES฀SALES฀PROCESS฀ IS฀MORE฀COMPLEX.฀YOU฀MAY฀NOT฀ KNOW฀THAT฀YOU฀NEED฀THE฀ PRODUCT฀฀–฀AN฀UNKNOWN฀KNOWN.฀ YOU฀PROBABLY฀HAVEN’T฀GOT฀THE฀ FAINTEST฀IDEA฀OF฀WHAT฀A฀DOUBLE฀ KNOCKOUT฀CURRENCY฀OPTION฀ WITH฀REBATE฀IS฀OR฀DOES฀–฀฀ A฀KNOWN฀UNKNOWN.฀WHAT฀SHOULD฀ YOU฀PAY฀FOR฀THIS฀PARTICULAR฀ ITEM?฀DEFINITELY,฀UNKNOWN฀ UNKNOWN.฀DERIVATIVES฀ARE฀ SIMILAR฀TO฀A฀MANOLO฀BLAHNIK฀฀ OR฀JIMMY฀CHOO฀PAIR฀OF฀฀ WOMEN’S฀SHOES.” traders13.indd฀฀฀1 9/3/06฀฀฀17:00:18 ‘This makes fascinating reading. … Old-fashioned financiers will read it and weep; today’s MBA students will probably just want to climb aboard this gravy train. Meanwhile, for anyone else, the book offers a good crib sheet for how the whole derivatives game works. Better still, there is barely an equation in sight.’ Financial Times ‘Billed as part thriller, part exposé, it is that true rarity: a derivatives book that keeps your attention all the way through … Beyond the entertainment value for those who recognise their friends and colleagues – and perhaps themselves – in the book, it also offers a good introduction to the world of derivatives for people in other areas of finance or even the man on the street who wants to know more.’ FOW ‘The author of this revealing insider’s account has spent over 25 years in what he calls “the realm of beautiful lies.” He strips bare the workings of a complex betting game – the book is peppered with cautionary tales. Das wittily exposes the mechanisms behind the arcane language of yield curves, option pricing and the rest.’ Director ‘Its spicy gossip about the goings on in the dealing rooms of investment banks makes for a riveting read – more riveting than yes, The Da Vinci Code.’ The Edge Daily, Malaysia ‘ … filled with examples of naïve investors sucked dry by sophisticated number crunchers who use smoke and mirrors to point to potential profits while stuffing the hard cash into their own pockets. … contains more than investor advice, with plenty of tales of gluttonous excesses and trading-floor antics gleaned from more than 20 years in the industry.’ South China Morning Post ‘a must read for all CEOs, CFOs, bankers and anyone who cares about what banks are doing with their money.’ Finance Asia [...]... intoxicating Derivatives suited me Fortuitously, I seemed to suit derivatives Traders, Guns & Money is the record of my time in the derivatives industry It is a collection of tales about the products, the people and the strange goings-on in the business Ordinary men and women do not trouble themselves about this world Just occasionally, an event such as Nick Leeson and Barings or LTCM spills over into the. .. for and against derivatives, it just shows what really goes on every day in the dealing rooms in major financial centres, the real life dramas and rational madness that shape modern markets Traders, Guns & Money is intended for two audiences People in banking and finance, whether or not they are involved in derivatives directly, will find it a wry and entertaining read They will recognize themselves... foreign businesses There were, of course, ‘problems’ The sudden increase in the rate of growth and demand set off rapid price rises The office space in Mumbai’s Narriman Point business district was among the most expensive in the world, a matter of national pride Productivity was pitiful The phones and plumbing did not work The traffic was horrendous Some experts even claimed to know the rules of the game... introduced these products into Asia products had seduced Asian companies and investors unfamiliar the Indonesians and with the abacus entered into complex many others transactions that they rarely understood The dazzling financial products had seduced the Indonesians and many others Now, some years later, the lawyers and accountants (with me in tow) were picking up the pieces of the inevitable disasters The. .. be in the area of shipping, especially in the arcane area of ‘bottomery’ This was the biggest case in the firm’s history The firm’s strong suit was litigation, Morrison had assured me, and it would need to be The establishment firm of Killem & Billem, acting on instructions from ^ the American dealer, was moving in to administer the coup de grace – they were seeking summary judgment Knowns and unknowns. .. sharply and found its level – rupiah 8,000 per dollar It stabilized, then went into free fall to rupiah 12,000 before rallying to 10,000 OCM were finished The crisis had caused Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve, to cut interest rates to support the financial system The fall in dollar interest rates and the collapse of the rupiah signa-lled the beginning of the end... rate OCM had mortgaged their futures to factors over which they had no control They needed divine intervention to save themselves from their own folly In the end, the miracle was not forthcoming Beginning of the end/end of the beginning In July 1997, as the Grand Master had predicted, the Asian boom began to unravel The Thai baht fell sharply The Thai Central Bank had spent Thailand’s entire foreign... were ‘unknown knowns – things that you did not know you knew Finally, there were ‘unknown unknowns – things that you did not know you did not know It also fitted the derivatives business Derivatives professionals dealt daily with combinations of knowns and unknowns The unknowns, both known and unknown, created fear and suspicion The knowns were synonymous with greed This was even before the Defense... into the trades of their own free choice.’ Neverfail wagged an accusatory finger in the general direction of the defence team ‘Your clients were provided with information about the trades They were fully aware of the nature of the transactions They signed disclaimers that state clearly that they were not relying on us They state clearly that they knew what the risks of the trades were They signed the. .. (weapons of mass destruction), causing large losses that affect markets, investors and banks There is almost no literature that explains the industry in an accessible way There is also little that sets out the practices, some of which are insane, of this mysterious area of finance Traders, Guns & Money explains the industry, how it operates and what it does The book does not attempt to make a case for and . derivatives. Traders, Guns & Money is the record of my time in the derivatives indus- try. It is a collection of tales about the products, the people and the strange goings-on in the business DAS “Make฀room฀for฀another฀must-read฀on the shelves฀฀ of any฀City฀or฀Wall฀Street฀trader,฀salesman,฀or฀victim.฀฀ Traders, Guns &฀Money฀is฀filled฀with฀dirty฀little฀ secrets,฀some฀old and some฀new.฀Anyone฀who฀฀ has฀worked฀on฀a฀trading฀floor฀will฀nod and laugh.฀ Those฀who฀have฀not฀will฀shake฀their฀heads and cry.฀ When฀ derivatives and ‘f******’฀appear฀together฀฀ on฀every฀other฀page,฀you฀know฀someone฀has฀written฀ the truth฀about฀financial฀innovation.฀Be฀afraid.”฀ Frank฀Partnoy,฀author of FIASCO and Infectious฀ Greed and Professor of Law฀at the University of ฀ San฀Diego “Very,฀very฀real.฀Risk฀management฀at the front฀line,฀฀ and unlike฀anything฀you’ll฀have฀seen in the textbooks.”฀ ฀ Paul฀Wilmott,฀writer,฀mathematician and author of ฀ the quantitative฀finance฀website฀www.wilmott.com Warren฀Buffet฀once฀memorably฀described derivatives ฀ as฀“financial฀weapons of mass฀destruction”.฀Read฀this฀ sensational and controversial฀account of the often฀ dazzling business of derivatives trading, and see฀if฀฀ you฀agree. No฀money฀is฀ever฀really฀made in financial฀markets.฀ Markets฀merely฀transfer฀wealth.฀As฀to฀how฀to฀make฀ money?฀Well,฀it฀is฀basically฀theft,฀misrepresentation,฀lies,฀ cheating,฀deception฀or฀force.฀It฀is฀impossible฀to฀make฀ the staggering฀amounts฀made in derivatives in good฀฀ years฀honestly. Traders, Guns &฀Money฀is฀a฀wry and wickedly฀comic฀ exposé of the culture,฀games, and pure฀deceptions฀ played฀out฀every฀day in trading฀rooms฀around the world, ฀ usually฀with฀other฀people’s฀money.฀Whether฀you฀move฀฀ in the financial world yourself,฀know฀people฀who฀do,฀or฀ have฀money฀invested in stocks,฀shares฀or derivatives, ฀ this฀is฀a฀fascinating฀read฀guaranteed฀to฀make฀you฀think.฀ “I฀had฀been in derivatives for฀over฀25฀years.฀฀ Many฀traders฀hadn’t฀been฀born฀when฀I฀ stumbled฀accidentally฀into the arcane world of derivatives trading.฀How฀did฀I฀get฀there?฀฀ I฀had฀followed the money.฀I฀had฀ridden the tide and currents of financial฀markets.฀I฀had฀ not฀known฀very฀much฀then.฀Even฀now฀I฀only฀ knew the many unknowns. ฀How฀did฀I฀get฀ here?฀It฀was฀a฀very฀long฀story. Traders, Guns &฀Money฀is฀that฀story…” Satyajit Das is฀an฀international฀expert in the dazzling world of financial derivatives and has฀ 25฀years’฀experience in the financial฀markets.฀ He฀has฀had฀a฀foot฀on฀both฀sides of the derivatives equation,฀having฀worked฀for฀banks฀ (the “sell฀side”)฀such฀as the Commonwealth฀ Bank of Australia,฀Citicorp฀Investment฀Bank฀฀ and Merrill฀Lynch and, ฀as฀Treasurer of the TNT฀ Group,฀for฀clients฀ (the “buy฀side”).฀He฀now฀acts฀ as฀a฀consultant฀advising฀banks and corporations฀ and presenting฀seminars฀throughout the world on the slippery฀subject of derivatives. Das is the author of a฀number of highly฀฀ regarded฀standard฀reference฀books฀on฀ derivatives including฀Swaps/Financial฀ Derivatives (2004,฀Wiley),฀Structured฀Products฀฀ &฀Hybrid฀Securities฀(2001,฀Wiley) and Credit฀ Derivatives, ฀CDOs and Structured฀Credit฀ Products฀(2005,฀Wiley).฀Outside the wild world of derivatives, Das is฀passionate฀about฀real฀ wildlife and is฀co-author฀(with฀Jade฀Novakovic)฀ of In Search of the Pangolin: The Accidental฀฀ Eco-Tourist฀(2006,฀New฀Holland),฀a฀unique฀฀ travel฀narrative฀focused฀on฀eco-tourism.฀ TELLS฀A฀CRACKING฀STORY,฀ AND IN DOING฀SO฀REVEALS฀ BOTH THE HARD฀FACTS AND THE SOFT฀UNDERBELLY OF THE WORLD OF DERIVATIVES ฀ IN MOST฀BUSINESSES, THE NATURE฀ OF THE PRODUCT฀IS฀A฀KNOWN฀ KNOWN.฀WE฀DO฀NOT฀SPEND฀A฀LOT฀ OF TIME฀DEBATING THE USE OF OR฀ OUR฀NEED฀FOR฀A฀PAIR OF SHOES.฀ WE฀ALSO฀UNDERSTAND฀OUR฀ CHOICES฀–฀LACE฀UP฀OR฀SLIP-ON,฀ BLACK฀OR฀BROWN.฀I฀SPEAK,฀฀ OF COURSE, OF MEN’S฀SHOES฀฀ HERE.฀WOMEN’S฀SHOES,฀WELL,฀ THEY฀ARE฀CLOSER฀TO DERIVATIVES. ฀ THE DERIVATIVES SALES฀PROCESS฀ IS฀MORE฀COMPLEX.฀YOU฀MAY฀NOT฀ KNOW฀THAT฀YOU฀NEED THE PRODUCT฀฀–฀AN฀UNKNOWN฀KNOWN.฀ YOU฀PROBABLY฀HAVEN’T฀GOT THE FAINTEST฀IDEA OF WHAT฀A฀DOUBLE฀ KNOCKOUT฀CURRENCY฀OPTION฀ WITH฀REBATE฀IS฀OR฀DOES฀–฀฀ A฀KNOWN฀UNKNOWN.฀WHAT฀SHOULD฀ YOU฀PAY฀FOR฀THIS฀PARTICULAR฀ ITEM?฀DEFINITELY,฀UNKNOWN฀ UNKNOWN. DERIVATIVES ARE฀ SIMILAR฀TO฀A฀MANOLO฀BLAHNIK฀฀ OR฀JIMMY฀CHOO฀PAIR OF ฀ WOMEN’S฀SHOES.” traders13.indd฀฀฀1. you’d like to find, you can visit www.pearsoned.co.uk Traders, Guns & Money Knowns and unknowns in the dazzling world of derivatives Satyajit Das PEARSON EDUCATION LIMITED Edinburgh Gate Harlow