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To: tcostell
I have read your interesting post several times. It just dosen't make sense to me. How can these derivatives positions be essentially "risk free" under all scenarios? That is what you are claiming, right?

If Morgan is not assuming risk what would be the point of the other party doing business with them?

The _bottom line_ issue is this:

Are there scenarios under which Morgan's derivatives exposure could bring down the bank? What are those scenarios?

I would appreciate your response since you obviously have some knowledge you could share.
18 posted on 07/28/2002 4:45:46 PM PDT by cgbg
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To: cgbg
You raise an important point. Each derivative in itself is not "risk free". But it's policy at JPMorgan to acquire opposing positions in such a way as to make them risk neutral in the ways that I mentioned.

As a basic example, JPMorgan agrees to provide a floating interest rate cashflow 4 times a year, for the next 10 years to a client bank of theirs. The amount of the payment will be calculated based on the fixing of the inter-bank offer rate, on the last day of the quarter, and will be in the notional amount of 10 million dollars. (this is a really small example, I'm just trying to make a point)

What they will then do is get two other people interested in the opposing side of the trade to make a deal for 5 million each. This is actually much easier than it would seem when you dominate a market like JP does. So every quarter they pay out on 10 million, and collect on 10 million, and in the meantime, they have made a fee for transacting the business.

But don't mistake the fact that they have managed risk, for them being risk neutral. They aren't totally risk neutral, but they do not have their risks connected in any way with the price of their stock.

In point of fact, it's significantly more complicated than that, but they have the best risk management team in the business, and have policies in place to see to it that things don't get out of control.

As another example, during my tenure there, the entire mortgage bond trading area was fired. Not because they were losing money, (they were, but not so much), but because it was the determination of the bank that since mortgage pre-payment cannot effectively be predicted, they could not effectively manage their risk. So that was that. 50 people were shown to the door, because risk management is top priority at JPMorgan.

The larger and more complicated a derivatives position is, the more complex the risk management, but they are not trying to make money on leverage, they are trying to make money on fees.

Does that help at all?

BTW, if you'd like more information on their risk management methodology, take a look at their website under "risk-metrics".

19 posted on 07/28/2002 5:13:03 PM PDT by tcostell
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To: cgbg
For a counterpoint see Doug Noland's analysis at prudentbear.com. While they are wise to straddle and probably effective in doing so they are beginning to straddle an ever widening crevasse as some of kinkier deals look less comforting to S&P.
27 posted on 07/28/2002 5:46:21 PM PDT by junta
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