Take on /less/ long term assets (sell them and buy t-bills) to remove the existential risk.
It's not going to be much different in cost. You see it? Derivatives aren't magic pixie-dust insurance. They will cost about the same as a rebalance on that scale or you hit them as hard as you can because they're mispriced and represent free money.
You /can/ manage short term liability mismatch against long term assets in one sense but it's actually useless when you think about why you have long term assets at all.
Just like you can manage the risk by selling your long term assets and buy short term to make the mismatch not exist.
The cost of managing using swaps will be about the same as selling your long term assets and buying t-bills. If it isn't, you hit it as hard as you can knowing it won't last and it's free money.
From a shareholder perspective, insurance "float" is a cheap form of leverage.
1. Take in $100 of premium, and put up $10 of your own money. Use that money to buy $110 of assets.
2. Set up $100 of reserves. Your $110 of assets is now backing $100 of reserves plus $10 of regulatory capital.
3. A year later, your assets are now worth $113, and you owe a claim of $100. Sell the assets, use $100 of proceeds to cover the cost of the claim, and keep the $13 that's left over.
Congratulations - you've earned a 30% annualized return on your $10 investment, despite the fact that you purchased assets yielding ~3% and didn't make an underwriting profit, because you were effectively able to lever up 10:1 at 0% interest.
The catch is, if claims had been ~3% higher than expected you would have broken even, and if they were ~10% higher than expected you'd have lost all your money. If you were a hedge fund instead, you wouldn't have to deal with that risk (or with any of the other aspects of running an insurance company), and you'd have much more flexibility in terms of assets. But you could only lever up maybe 3:1 instead of 10:1, and your cost of debt would be much higher.
You can sort of fix this in a free market system through reinsurance which spreads the risk out across multiple counterparties with deep capital reserves. But ultimately the only way to eliminate the risk is through insurance by a sovereign with the ability to levy taxes and print fiat currency.
How far can you go with that strategy? The derivative assets aren’t going to fully move with the price, and can have much higher volatility than the asset you’re trying to avoid buying.
It’s largely there to sound scary. While stocks can have their exposure measured based on their face value, derivatives cannot. For example, you could have a 100 million interest rate swap, where you either pay or receive the difference between a floating interest rate and a fixed interest rate depending on their values. You’ll never get close to ever losing or gaining 100 million dollars, and that 100 million is never exchanged, but you still have that much exposure.
To further complicate things, these banks may have hedged their exposure, meaning they may have an equal but opposite interest rate swap. Now they have 200 million of exposure, but no matter how the interest rates have changed, there’s no risk (all of this assumes no counterparty risk, which may or may not be valid, but for now ignore it).
I don't think you understand derivatives. They assist in resource allocation by applying pressure to the future value of goods, so that we have more control to hedge our risks.
Not to quibble, but I would say that using SRS and SKF doesn't really qualify as using "complex derivatives" to bet against the market.
For most investors there really wasn't an optimal way to do this, using ultra-short ETFs carried a lot of drawbacks. The best way (which I found and put 50% of my PA into) was to go long a Canadian insurer which had a ton of credit default swaps on most of the levered investment banks.
The other thing I would say is that, unless you are somehow exacerbating a problem (e.g.: somehow creating rumors to cause bank runs) then picking up cheap insurance isn't the same as being the guy controlling the predator drone in a strike. You'd instead be simply offsetting someone else's risk.
Insurance and derivatives are supposed to find prices for rare events. And if an organization can't insure or securitize a risk it should make them think real hard about mitigation.
Options and many other derivatives are not merely a casino game. Their unique role as financial instruments is to allow the transfer of risk from those who have risk and don't want it (hedgers) to those who don't have any risk and do want it (speculators). This is different from gambling because gambling by definition involves the creation of entirely new risk for the purpose of wagering; derivatives transfer pre-existing risk that will continue to exist anyway even if the derivative didn't exist. This is identical to the more familiar role of an insurance company in everyday life.
For example, suppose someone has a long term stock portfolio -- a classic fundamentals investor with a decades-long time horizon, the farthest thing from a casino style gambler you can find in the stock market. Maybe it's a pension fund or an institutional endowment. They very much do not want to take highly risky short term bets. They are only interested in safe, slow, long term returns.
But markets can only provide that in aggregate. In the short term, markets are very unstable, and individual stocks go to 0 if the company folds. The long-term investor thus constructs a portfolio of many small investments rather than a few big ones.
The portfolio manager has reason to believe that XYZ, one of the portfolio companies, is about to go bankrupt. This is not certain, but the stock has already begun to drop. If the stock drops to 0, the portfolio stands to lose a lot of money (despite continuing to exist overall because of diversification.)
The portfolio manager can buy put options to hedge XYZ. These give the holder the right to sell XYZ stock at a certain price, regardless of its current market price.
In this case, they function as a form of insurance. If the rumors are false, XYZ stock will bounce back up and the put expires worthless. If the rumors are true, XYZ drops to 0, but the portfolio manager can still sell his XYZ stock to the speculator who sold him the put option at a pre-determined price.
This is no different from buying fire or flood insurance on your house -- if the value of your house goes to 0 through disaster, you can in essence sell that worthless house to the insurance company for a predetermined price and buy another house. Options are the stock market version of that.
If you tax them more heavily, that will make them more expensive to use, which will discourage people from using them and arguably increase instability while decreasing growth in the stock market as everyone will be forced to carry the full value of any losses themselves, with less possibility for insurance.
The example of financial derivatives is really strong: on the market it's basically a form of gambling. Will this thing go up and down? Noone knows, but you're a genius if it works and a loser if not. But if you own something and hedge by e.g. getting puts it's a form of insurance.
So the instrument is the same, it's the intent that makes it different.
If I'm a big company, like Delta, I want to make sure my profits are based on my efficiency at my core business, like operating an airline, not some random thing like the fluctuations of oil prices. So, I'd like to buy a contract that insures me against high oil prices. To pay for that insurance contract, I'd sell a contract that gives away my excess profits that might accrue if oil fell. These contracts are derivatives of oil, not oil itself.
A healthy derivatives market helps businesses focus on producing useful things for society. Every human should buy health insurance. Every big business should buy commodities and currency insurance (they don't call it that).
An unhealthy derivatives market encourages business to gamble rather than produce. GE Capital, before it got shut down, was at one point a bigger business than the rest of GE.
Well, those swings won't hurt you if you hold. That's the point. But if you were like a farmer and had to sell at a certain point, the protection could be through derivatives. You might do the same with stocks if you were planning to sell at a given time in the future (eg, if you planned on buying a house in 2022).
Yeah, I haven't explored this yet. The unlimited risk thing bothers me thought. Which probably sounds funny since this whole things is risky as hell. But, I was more looking into options or something to hedge but honestly everything takes so much time to learn about, test, and then do. So, I just wanted to focus on this and then expand.
It's not going to be much different in cost. You see it? Derivatives aren't magic pixie-dust insurance. They will cost about the same as a rebalance on that scale or you hit them as hard as you can because they're mispriced and represent free money.
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