I have been hearing a lot of late concerning derivatives and how they can cause the biggest collapse the world has known.
Wikipedia defines derivatives as:A derivative is a financial contract which derives its value from the performance of another entity such as an asset, index, or interest rate, called the "underlying".[1][2] Derivatives are one of the three main categories of financial instruments, the other two being equities (i.e. stocks) and debt (i.e. bonds and mortgages). Derivatives include a variety of financial contracts, including futures, forwards, swaps, options, and variations of these such as caps, floors, collars, and credit default swaps. Most derivatives are marketed through over-the-counter (off-exchange) or through an exchange such as the Chicago Mercantile Exchange; while most insurance contracts have developed into a separate industry.
https://en.wikipedia.org/wiki/Derivative_%28finance%29James Rawles writes:Interest rate turmoil again affected holding company trading revenues heavily in the first and second quarters of 2013. According to the latest report from the U.S. Office of the Compttroller of the Currency (OCC), rate trading derivatives losses were $3.018 Billion in 1Q 2013 and $3.804 Billion in 2Q 2013.
It is noteworthy that the present-day casino in credit derivatives has built up in the era of ZIRP, where interest rate changes have been miniscule. The losses reported in the first two quarters were apparently triggered by the unexpected rate moves of less than 20 basis points. (Two tenths of one percent.)
While the total credit exposure to risk based capital has declined for the top four U.S. commercial banks that do derivatives trading, the notional value of their derivatives increased by $2.2 trillion, to $233.9 trillion. And JPMorgan (the world's biggest derivatives trader) just by itself holds derivatives contracts with a notional value of around $71 Trillion! (To be precise: $71,289,673,000,000.) To put that in perspective, the total value of the US economy is around $15 trillion.
The counterparty risk in credit derivatives would be gigamongous, if interest rates were to spike several full points, and any large institutions then subsequently failed. If you thought that the bailouts back in 2009-2010 were huge, then just wait and see what the next credit crisis brings. - JWR
So with $233.9T bet in the derivatives market, and they bet against things like, interest rates, crude oil, value of a currency: And our current economy is around $15T , plenty of opportunity for disaster.
I brought this up hoping that someone may know more than I do about derivatives (Which is nothing) and could share their knowledge on the subject.
