Traders,Guns and

Money

Knowns and unknowns in thedazzling world of derivatives

Revised edition

SATYAJIT DAS

PEARSON

Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney

Auckland • Singapore • Hong Kong • Tokyo • Seoul • Taipei • New Delhi

Cape Town • Sao Paulo • Mexico City • Madrid • Amsterdam • Munich • Paris • Milan

Contents

Publisher's acknowledgements xiiiList of figures and tables xivAbout the author xviIntroduction to the paperback edition xvii

PROLOGUE 1

Miracles and mirages 3Serial crimes 6Beginning of the end/end of the beginning 11Knowns and unknowns 14Unreliable recollections 16Summary judgment 21

1 FINANCIAL WMDS - DERIVATIVESDEMAGOGUERY 23

School days 26It's all Chinese to me 27A derivative idea 28Betting shops 30Secret subtexts 32Leveraged speculations 34Under the radar 39Whole lotta swapping going on 40The golden age/LIBOR minus 50 44

TRADERS, GUNS AND MONEY

Warehouses 47Serial killings 51Forbidden fruit 53Derived logic 60

2 BEAUTIFUL LIES - THE 'SELL' SIDE 62Smile and dial 64Market colour 66Rough trade 70Analyse this 73Class wars 76Ultra vires 78Feudal kingdoms 79Uncivil wars 81Golden rules 82Business models 83The medium is the message 87Bondage 89Tabloid cultures 90Conspicuous currency 91Ethnic cleansing 93Foreign affairs 94FILTH 96Lost in translation 97A day in the life 98

3 TRUE LIES-THE'BUY'SIDE 101Turn of the fork 102Risky business 103Magic kingdoms 106Stripping or stacking/hedging perils, again 110Me too 113'Zaiteku' or the bride stripped bare 114The gamble in P & G 118 >Tobashi, baby 122Gnomes of Zermatt and Belgian dentists 125Death swaps 126Investment fashions 129

CONTENTS

Alpha, beta, zeta 132Looking after the relatives 135Agents all 136Unique selling propositions 137

4 SHOW ME THE MONEY - GREED LOST ANDREGAINED 141

Money uncertainty 142Toll booths 143Take a seat 145Efficient markets 147On the platform 148A day at the races 151Black swans, black sheep 151Trading places 152Secret intelligence 155Overwhelming force 157Oracle of Delphi 157Free money 160The colour of money 162In reserve 163A comedy of errors 165Black holes 166What's the number? 171Nothing like excess 172Nice work if you can get it 174Dukes of Hazard 176

5 THE PERFECT STORM - RISK MISMANAGEMENTBY THE NUMBERS 178

Shock therapy 179Holy risk! 180Risk spin 181Risque matters 184 \Placebo effects 186Among the unbelievers 189Risk cults 191In the long run . . . 195

TRADERS, GUNS AND MONEY

Modus operandi 197Secret trader's business 198Let the good times roll 199The perfect storm 200Weather forecasts 202Endgame 204Mean risk 205Extreme sports 206

6 SUPER MODELS - DERIVATIVE ALGORITHMS 209Out of the sheltered workshops 210 -Rocket science 212Culture wars 214Conveyor belts 216Trivial pursuits 217Grand oprey 219The quest 220Genesis 223Gospels 227Greek tragedies 230Failing the model test 232CSI (Crime Scene Investigation) 1987 - 'Oh LOR-dy!' 235CSI1992 - ERM (extremely risky, man!) 236CSI 1998 - selling England by the pound 237CSI 1998 - Asian fever 240Model envy 241Omitted variable bias 243

7 GAMES WITHOUT FRONTIERS - THE INVERSEWORLD OF STRUCTURED PRODUCTS 245Driving over lemons 247The best of times . . . the worst of times 248Ghostbusters 250It wasn't me, sir 251Heaven and hell 252Split personality 256Golfing holidays 258The flood 261

CONTENTS

Power to the people 263Recycling junk 267Six packs 270Take no prisoners 273The usual suspects 275

SHARE AND SHARE ALIKE - DERIVATIVEINEQUITY 279

Billion dollar baby 280Self arbitrage 283Arbitraging others 285Taking it over 287Buying back the farm 288Who's fooling who? 289Strippers 293Pearls of wisdom 295Own goals 298Taxing times 301Fund times 304

CREDIT WHERE CREDIT IS DUE - FUN WITHCDSANDCDO 308

Credit wars 309Credit epiphanies 311First-to-credit derivatives 312Remote credit 315Mistaken identity 318Heard it on the grapevine 321Guaranteed delivery 322Re-re-re-re-restructuring - CDS stutters 324Beyond the push and pull 326Imitation and flattery 328Tranche warfare 332It's super 334 ,A capital idea 336The arbitrage age 337Hangovers 338UFOs 339

TRADERS, GUNS AND MONEY

Geeks with Greeks 340Never believe your own lies 343Russian dolls 345Black holes 347

EPILOGUE 350The Asian century redux 351Vexatious litigation 355The more things change 358Hot tubbing 361Rogue trader 364Bangs and whimpers 368The China Club 369BOAT (Best of all time) 370Knowns and unknowns 371

AFTERWORD: CREDIT CRUNCH - THE NEWKNOWN KNOWN OF FINANCIAL MARKETS 374Living in the Age of Kali ... 374Supersize my debt! 375Would you like debt with that? 377The new liquidity factory 379Lying NINJA mortgagors 379The lines of transmission 382It's different this time! 384The bear comes out of hibernation 385Waiting for the other shoe to fall ... 387Financial shell games 389The short and long of it all 391Model shock 392Missing the'mark 393Truth in labelling 396Regulatory irregularities 398Reversion to mean 400 ;Credit crunch 401

Notes 402Index 408