Credit deflation and the reflation cycle to come (part 2)

[DurhamBorn]

15 hours ago, Heart's Ease said:

A snippet from the FTs 'opening quote' piece about Imperial (just picked up from Twitter). I know FT do not welcome full pastes of their articles so only brought this over. Results on Tuesday.

"But Imperial also warns it is taking a “more cautious approach” to its outlook for 2020. It predicts “low single digit” revenue and earnings per share growth, and that is partly dependent on its vaping efforts getting back on track. For now, it has cut back investment on “next generation products” while regulatory uncertainty lingers and competitors discount in a fight for consumers."

1% earnings growth will look amazing compared to what a lot of companies will be facing.This is a company that makes £2.5 billion in free cash flow and has Capex needs of only £100 million a year.Divi growth will be tiny if anything over the next several years,but likely they will way outperform the marker on total return.The vaping space is cut throat though and Imperials efforts there have been crap,plus they are behind on heat not burn,though are getting going with it.They need vaping to be regulated to be able to control the market.Since i was 14 iv heard the line fag companies are toast a few times and each time i bought the shares.The first time they paid off my mortgage,the 2nd time they delivered 1000%.This time i think maybe "just" 100%.I prefer BAT,but Imperial should deliver.

[DurhamBorn]

10 hours ago, Heart's Ease said:

Keiser reports 1457/58 are worth a listen. Both ranging on and around the central premise of this thread and for these episodes pulling in Wolf, Saudi over depletion of oil fields, miners, silver, repo market (Max tips up JP Morgan for insolvency) etc etc.  Basically, everything bar the pizza oven.

I reckon its Citibank in trouble,time will tell.

[Majorpain]

6 hours ago, DurhamBorn said:

I reckon its Citibank in trouble,time will tell.

Rumours are circling about Deutsche filing for bankruptcy, not particularly surprising but if true the CB's will be keeping it under wraps as much as possible whilst they try and defuse the derivatives time bomb IMO.  Way too much leverage involved these days.

[BearyBear]

Gold Bulls have a great opportunity to smash Bears who joined the yesterday's sell-off and/or had theirs sell stop orders below $1480 filled.

2 hours ago, Majorpain said:

Rumours are circling about Deutsche filing for bankruptcy, not particularly surprising but if true the CB's will be keeping it under wraps as much as possible whilst they try and defuse the derivatives time bomb IMO.  Way too much leverage involved these days.

We've seen these rumours for good 10 years...

[Talking Monkey]

2 hours ago, Majorpain said:

Rumours are circling about Deutsche filing for bankruptcy, not particularly surprising but if true the CB's will be keeping it under wraps as much as possible whilst they try and defuse the derivatives time bomb IMO.  Way too much leverage involved these days.

I just can't see how they would let a mega bank fail, some sort of plan would be cobbled together

[DurhamBorn]

The problem isnt the bank its the derivatives affect rolling out.I still think Citi bank could prove a big problem for reasons i wont go into,but the knock on affect will be brutal.This thread is about the debt deflation in action and the macro affects.The real big one comes from the derivatives contracting,and an ill liquid run for the exit.That will jam up the credit markets and people wont be able to re-finance apart from rock solid high cash flow companies.I have a feeling the big insurers also could have a lot of crap on their balance sheets that they dont know is crap.A lot of the "growth" companies who need more debt wont get any and will have to do equity at massive dilution of go under.

The irony is the very stocks beaten down in the old economy are the ones who will soak up all inflation the CBs will be forced to pump.The Tories are pulling a blinder getting this election done before the real fun as 5 years time should be right at the boom stage of the recovery cycle.

[Majorpain]

1 hour ago, BearyBear said:

We've seen these rumours for good 10 years...

Indeed, but its the old saying of going bankrupt in two ways. Gradually, then suddenly.

Its been a very long, slow and painful death for Deutsche.

[kibuc]

New Gold reported its financials.

At this stage I'm only interested in it for shits and giggles, so only a brief overview:

AISC $1318, compared to $1087 in Q2 

AISC at Rainy River $1593, up from $1314 

Funnily enough, it's still below their revised guidance from mid-year but damn, those are some high numbers.

Now, turning to low numbers, average realized gold price $1383, roughly $100 lower than average spot price for the quarter. Keep hedging, guys.

Disclaimer: no position 

[Sugarlips]

1 hour ago, DurhamBorn said:

The problem isnt the bank its the derivatives affect rolling out.I still think Citi bank could prove a big problem for reasons i wont go into,but the knock on affect will be brutal.This thread is about the debt deflation in action and the macro affects.The real big one comes from the derivatives contracting,and an ill liquid run for the exit.That will jam up the credit markets and people wont be able to re-finance apart from rock solid high cash flow companies.I have a feeling the big insurers also could have a lot of crap on their balance sheets that they dont know is crap.A lot of the "growth" companies who need more debt wont get any and will have to do equity at massive dilution of go under.

The irony is the very stocks beaten down in the old economy are the ones who will soak up all inflation the CBs will be forced to pump.The Tories are pulling a blinder getting this election done before the real fun as 5 years time should be right at the boom stage of the recovery cycle.

Appreciate this is crystal ball but when you say jam up credit markets DB are you expecting the main impact to be felt  in the corporate world or would such illiquidity lock up the mortgage market and therefore housing as well?

[Majorpain]

2 hours ago, Talking Monkey said:

I just can't see how they would let a mega bank fail, some sort of plan would be cobbled together

Deutsche Bank total derivatives exposure: $53.5 Trillion (July 19)

German GDP: $4 Trillion (2018)

So if the damage is around 7-8% then Deutsche Bank would have lost more than the entire German economy generated in 2018.

Its not just too big to fail, its potentially too big to bail depending on how the derivatives work out.  No-one (not even Deutsche IMO) yet knows what the damage would be.

[Talking Monkey]

8 minutes ago, Majorpain said:

Deutsche Bank total derivatives exposure: $53.5 Trillion (July 19)

German GDP: $4 Trillion (2018)

So if the damage is around 7-8% then Deutsche Bank would have lost more than the entire German economy generated in 2018.

Its not just too big to fail, its potentially too big to bail depending on how the derivatives work out.  No-one (not even Deutsche IMO) yet knows what the damage would be.

It says something about the regulatory regime if even DB don't know the fallout, makes a mockery about all the talk about stress tests etc

[sancho panza]

On 05/11/2019 at 13:21, MvR said:

Mechanically, futures trading is pretty straight forward. I just select the symbol (/ES, /CL etc) and select the expiry month. Interactive Brokers defaults to the nearest month, which is the one most people trade so is the most liquid and offers the most accurate short term technical signals.

I've also sold options on futures to achieve greater diversification in my Income Options account.  Selling individual equity options offers a decent return when the market is playing nice, but they all become highly correlated during a correction so can lead to some painful losses. Being able to sell options on things like oil, wheat, silver, cattle, coffee, etc means I can be in more non-correlated markets at the same time, and they're more likely to stay non-correlated.

I could sell options in single commodity ETFs, but I've found these to be either too small, requiring a large number of contracts and therefore larger commissions,  or too illiquid to get decent prices, or both.

I also like futures for sniper type day-trading. I've used spread-betting for this in the past, but the new, larger margin requirements make this impractical for me. When trading this way I like to have super-tight stops, and spread-betting margins no longer take this into account. I'd need to tie up more cash in the account to trade at reasonable size.  I still day-trade with spread-betting for fun sometimes using their minimal contract size, where a "big win" is something around £10, and a loss might be around £5. Trading this way a few times a month also gets me a free subscription to IG's nifty ProRealTime charts.

Day-trading futures allows larger, more useful sized trades, and I can make them in the same accounts I use for options trading too, which makes for more flexible capital allocation. I can also trade options against a given futures position.

One can also trade futures spreads - eg long a near month, and short a further out month. This can be a neat way to trade changing interest-rate expectations for example, or take a agricultural commodity position based on the weather, how healthy the crops look in the fields etc.  I've only scratched the surface with this kind of trading, but I find it fascinating. Tastytrade.com has couple of great futures education shows with Pete Mulmat. Well worth tuning in for to learn about this advanced stuff.

The other great thing about futures for day-trading purposes is that it's the futures market that drives the market overall. This means they offer the best, most accurate technical, volume and price action signals.  /ES is the most traded contract of all, and if you're trading with super-tight stops, it gives the best chance to get a good entry based on extremely short term charts.

it appears that there are lots of treasuries to buy ( or short ) with very near term expiries, or rather "maturities". These often started out as longer term bonds/bills, which are close to their maturity dates. I just had a look and there are 8 standard treasury bills to choose from which mature this month alone.

Bond commissions on Interactive Brokers seem to have a minimum of $5 to $7.5 per trade, ( depending on which exchange the order is executed on ).  I've run a couple of examples here, based on a US-T bill maturing on 29/11/2019, about 3 1/2 weeks away. ( A treasury bill is just the name for a short term treasury bond ).

If I'm understanding things correctly ( which is by no means certain! ), and the bond will settle for $1000 on maturity, so in this case, it appears the trade would be roughly a $6.50 loser.  

Upping the trade size to $10,000 means it would make about a dollar... I think.

The maintenance margin requirement to hold these bonds is very small, just under $8 per $1000 lot, so even if I chose to convert most of the cash in my trading account to bonds, it doesn't prevent me trading other things. Understandable really, since US-Ts are perfectly good as collateral.

Obviously there's no point leveraging up to hold lots of bonds long term. The interest rate I pay the broker would be more than I make on the bond. That's a game for banks and other big institutions.  But as a leveraged short-term trade... possibly, though bond futures, or options on bond futures, may be a safer bet. A limited-risk options spread means my maximum loss is known on order entry, regardless of what the market does.

The symbol, btw is US-T, at least on Interactive Brokers.  It took me a while to figure this out.

Disclaimer. All this is based on what I've figured out this morning. Definitely DYOR as I am no expert!

Fascinating insight MvR.

I've only ever traded options of UK stocks before.Both writing and trading.Spreads were wide so not suited to short term trading unless you went for the indices.

There was a dsitinct lack of liquidity at the Liffe.

At the moment,I don't really have the spare time to dig further and I'm likely at leats 6 months plus away from needing.However,I'm extremely interested  in trading options on UST's if it's possible given that it would mean we could make our call and then if it doesn't pan out we're not stuck witha  shedload of UST's until maturity which could be a fate if $ weakens when things have settled post drop.

The only reason I'd be buying bonds is for capital gain.The income is derisory.I feel sorry for the many British people who's pensions are stuffed to the gills with sub 4% 30 year gilts

We'll jsut be trading for cash/limited liability as I have to think if anything happens to me-not impossible-then noone else in teh family,will really have a clue what to do.

 

We're now up and runnign with Interactive Investor and Saxo so many thanks to all on here who've given advice/guidance.Interactive Brokers will be next.Surprised Saxo are so much more expensive than IB....and more generally I can't get my head aroudn the flexibility of teh accoutns avaialable online nowadays.Some really obscure markets are now open to retial which is a great thing.

 

I'm going to have to start watching a few tutorials.Many thanks as ever MvR

[sancho panza]

19 hours ago, kibuc said:

Endeavour Silver reported today. 

AISC $21.52 net of gold credits.

Considering El Cubo closure. 

Dżizas kurwa ja pierdolę. 

Luckily we sold out when I reorganized in early Sept.Not a great picture on the tweet but many thanks for the heads up as have  follwoed him on Twitter.

13 hours ago, Bear Hug said:

That looks like a useful twitter account, thanks for the link.  I find it really interesting looking at all the PM miners and seeing either none at all or huge PE ratios.  Is Fresnillo the only one actually making any money?

There are a lot fo them making money.Key thing to look at-dyor natch-is how generally unleveraged the PM miners are after 6/7 years of having to grovel in Wall St fro loans.

I'd say the majoirty of GDXJ companies have equity that's well ahead of liabilities

In a credit deflation,gold up,means liabilities will drop even further.

5 hours ago, Majorpain said:

Rumours are circling about Deutsche filing for bankruptcy, not particularly surprising but if true the CB's will be keeping it under wraps as much as possible whilst they try and defuse the derivatives time bomb IMO.  Way too much leverage involved these days.

DB has been at the epicentre of the rumours for years,which most likely means there's someone else in deeper trouble .iirc lehman was only spoken about on obscure parts of the interweb by people in the know.

aka Mr Mortgae from August 2008 but he'd been on about it since earlier in the year.It's about working out where the next crisis will come from.Car loans-too small,commercial real estate,resi real estate, junk bond market

Persoanlly,I think the really risky loans currently sit in CRE and junk bonds

https://wolfstreet.com/2019/11/04/leveraged-loan-downgrades-spike-collateralized-loan-obligations-clo-get-cold-feet-trigger-selloff-b-rated-loans/

2 hours ago, DurhamBorn said:

The problem isnt the bank its the derivatives affect rolling out.I still think Citi bank could prove a big problem for reasons i wont go into,but the knock on affect will be brutal.This thread is about the debt deflation in action and the macro affects.The real big one comes from the derivatives contracting,and an ill liquid run for the exit.That will jam up the credit markets and people wont be able to re-finance apart from rock solid high cash flow companies.I have a feeling the big insurers also could have a lot of crap on their balance sheets that they dont know is crap.A lot of the "growth" companies who need more debt wont get any and will have to do equity at massive dilution of go under.

The irony is the very stocks beaten down in the old economy are the ones who will soak up all inflation the CBs will be forced to pump.The Tories are pulling a blinder getting this election done before the real fun as 5 years time should be right at the boom stage of the recovery cycle.

yep,yep,yep.

That Wolf St report really is quite damning.There' s lot of junk lending gone on to zombie businesses

 

 

49 minutes ago, Sugarlips said:

Appreciate this is crystal ball but when you say jam up credit markets DB are you expecting the main impact to be felt  in the corporate world or would such illiquidity lock up the mortgage market and therefore housing as well?

I think it goes without saying that loan markets will jam up particualrly if you're not a prime borrower at either a commercial or personal level.

 

[MvR]

1 hour ago, sancho panza said:

 I'm likely at leats 6 months plus away from needing.However,I'm extremely interested  in trading options on UST's if it's possible given that it would mean we could make our call and then if it doesn't pan out we're not stuck witha  shedload of SUT's until maturity which could be a fate if $ weakens when things have settled post drop.

The only reason I'd be buying bonds is for capital gain.The income is derisory.I feel sorry for the many British people who's pensions are stuffed to the gills with sub 4% 30 year gilts

We'll jsut be trading for cash/limited liability as I have to think if anything happens to me-not impossible-then noone else will really have a clue what to do.

..

I'm going to have to start watching a few tutorials.Many thanks as ever MvR

You're very welcome. And thank you for all your company analysis / COMA rating work, which is extremely useful and educational for me!

To trade the options on US-Ts,  you've basically got a choice between options on TLT, options on the shorter dated Treasury Notes ( up to 3 years I think?) via the /ZN futures contract, and options on the longer dated Treasury Bonds ( 10 year +) via the /ZB futures contract.

These are all extremely liquid, both the futures contracts themselves and the options on them.  The options are settled with the futures contract dated just after the options expiry.  The futures contract, when it expires, is then settled for cash. You don't end up stuck with an actual Treasury Bond, so if you get run over by a bus, there's nothing complex your family need to do. it should all settle out to cash of it's own accord, with just a few days potentially unlimited market risk. So don't die on the eve of a banking crisis.. ( besides, you'd miss all the fun!  )

You might also want to look at the /GE futures contract, which tracks the Eurodollar rate, otherwise known as the infamous LIBOR.  Basically it's the rate at which dollars are loaned between banks anywhere outside the US, and despite its name, has nothing to do with the Euro. 

It's a good "fear index" of sorts, and since it's entirely market driven and not directly influenced by the Fed, it can be act as a useful signal, as well as a trading instrument. You can trade options on this too, again extremely liquid, and there are futures contracts available going out 10 years into the future, with options on these going out as far as 2023. Its charts tend to go back further in time than /ZB or /ZN too (depending on the platform), which is nice.

Actually, regarding your disaster scenario, to be extra safe, it's a good idea to add a second authorised user to your IB account, with specific trade rights ( I assume Saxo might offer this too? ),  and leave clear instructions they can follow to immediately close all positions in an emergency. If it's someone with no trading experience, these instructions could consist of the phone number to call, account number and password etc, and exactly what to say to the broker.  Closing out all positions in IB is pretty much a single click operation.. maybe with an "are you sure?" confirmation, so I'm sure this could be done over the phone as well. IB support staff are really helpful and could advise on exactly the best way to set this up. 

[sancho panza]

1 hour ago, Majorpain said:

Deutsche Bank total derivatives exposure: $53.5 Trillion (July 19)

German GDP: $4 Trillion (2018)

So if the damage is around 7-8% then Deutsche Bank would have lost more than the entire German economy generated in 2018.

Its not just too big to fail, its potentially too big to bail depending on how the derivatives work out.  No-one (not even Deutsche IMO) yet knows what the damage would be.

Mate of mine was kept on after Lehman went and a team was tasked with working out the derivatives exposure or some other similar task and he told me they jsut guessed in the end.

Banks these days aren't liabilities balanced against cash and CB reserves but rather delicate balances between asset prices/values and liabilities.Mismatches could be huge during a sell off.

And worth noting that the comment of William White who once said the best way to regualte banks was to let one go bust once in a while.We've had ten years of extend and pretend with taxpayer subsidized cheap interest rates.Not gonna be pretty when it ends

edit to add

an articvle jsut pointing out the symptoms of a collapse are there but it's jsut a working diagnosis at the moment.

http://theeconomiccollapseblog.com/archives/the-deutsche-bank-death-watch-has-taken-a-very-interesting-turn

The biggest bank in Europe is in the process of imploding, and there are persistent rumors that the final collapse could happen sooner rather than later.  Those that follow my work on a regular basis already know that this is a story that I have been following for years.  Deutsche Bank is rapidly bleeding cash, they have been laying off thousands of workers, and the vultures have been circling as company executives desperately try to implement a turnaround plan.  Unfortunately for Deutsche Bank, it may already be too late.  And if Deutsche Bank goes down, it will be even more catastrophic for the global financial system than the collapse of Lehman Brothers was in 2008.  Germany is the glue that is holding the EU together, and so if the bank that is right at the heart of Germany’s financial system collapses, the dominoes will likely start falling very rapidly.

There has been a tremendous amount of speculation about Deutsche Bank over the past several days, and so let’s start with what we know.

We know that Deutsche Bank has been losing money at a pace that is absolutely staggering…

Deutsche Bank reported a net loss that missed market expectations on Wednesday as a major restructuring plan continues to weigh on the German lender.

It reported a net loss of 832 million euros ($924 million) for the third quarter of 2019. Analysts were expecting a loss of 778 million euros, according to data from Refinitiv. It had reported a net profit of 229 million euros in the third quarter of 2018, but a loss of 3.15 billion euros in the second quarter of this year.

If you add the losses for the second and third quarter of 2019 together, you get a grand total of nearly 4 billion euros.

How in the world is it possible to lose that much money in just 6 months?

If all they had their employees doing was flushing dollar bills down the toilet for 6 months, it still shouldn’t be possible to lose that kind of money.

When investors learned of Deutsche Bank’s third quarter results last week, shares of the bank went down about 8 percent in a single day.

Overall, the stock price has lost over a quarter of its value over the past year.

Unless you enjoy financial pain, I have no idea why anyone would want to be holding Deutsche Bank stock at this point.  As I have previously warned, it is eventually going to zero, and the only question remaining is how quickly it will get there.

We also know that Deutsche Bank has been laying off thousands of workers all over the world…

On July 8, 2019, thousands of Deutsche Bank employees across the globe arrived at their offices, unaware that they would be leaving again, jobless, just a few hours later. In Tokyo, entire teams of equity traders were dismissed on the spot, while some London staff were reportedly told they had until 11am to leave the bank’s Great Winchester Street offices before their access cards stopped working.

The job cuts, which totalled 18,000, or around 20 percent of Deutsche Bank’s workforce, were the flagship element of a restructuring plan designed to save the ailing German lender.

The day before those layoffs happened, most of those employees would have probably told you that Deutsche Bank is in good shape and has a very bright future ahead.

Just like we witnessed with Lehman Brothers, there is always an effort to maintain the charade until the very last minute.

But the truth is that anyone with half a brain can see that Deutsche Bank is dying.  There have been so many bad decisions, so many aggressive bets have gone bad, and there has been one scandal after another…

In April 2015, the bank paid a combined $2.5bn in fines to US and UK regulators for its role in the LIBOR-fixing scandal. Just six months later, it was forced to pay an additional $258m to regulators in New York after it was caught trading with Myanmar, Libya, Sudan, Iran and Syria, all of which were subject to US sanctions at the time. These two fines, combined with challenging market conditions, led the bank to post a €6.7bn ($7.39bn) net loss for 2015. Two years later, it paid a further $425m to the New York regulator to settle claims that it had laundered $10bn in Russian funds.

At this point, it is just a zombie bank that is stumbling along until someone finally puts it out of its misery.

Money is so tight at Deutsche Bank that they have even cancelled the Christmas reception for retired employees…

Times change. Once upon a time (2001, in fact), Deutsche Bank was able to book stars like Robbie Williams for its staff Christmas party, with a Spice Girl turning up too just because it was such a great party. Now, according to the FT, Christian Sewing has even cancelled the daytime coffee-and-cake Christmas reception for retired employees.

Of course saving a few bucks on coffee and cake is not going to make a difference for a bank with tens of trillions of dollars of exposure to derivatives.

Deutsche Bank is the largest domino in Europe’s very shaky financial system.  When it fully collapses, it will set off a chain reaction that nobody is going to be able to stop.  David Wilkerson once warned that the financial collapse of Europe would begin in Germany, and Jim Rogers has warned that the implosion of Deutsche Bank would cause the entire EU to “disintegrate”…

Then the EU would disintegrate, because Germany would no longer be able to support it, would not want to support it. A lot of other people would start bailing out; many banks in Europe have problems. And if Deutsche Bank has to fail – that is the end of it. In 1931, when one of the largest banks in Europe failed, it led to the Great Depression and eventually the WWII. Be worried!

Sadly, most Americans can’t even spell “Deutsche Bank”, and they certainly don’t know that it is the most important bank in all of Europe.

But those that understand the times we are living in are watching Deutsche Bank very carefully, because if it implodes global financial chaos will certainly follow.'

[Castlevania]

3 hours ago, Majorpain said:

Deutsche Bank total derivatives exposure: $53.5 Trillion (July 19)

German GDP: $4 Trillion (2018)

So if the damage is around 7-8% then Deutsche Bank would have lost more than the entire German economy generated in 2018.

Its not just too big to fail, its potentially too big to bail depending on how the derivatives work out.  No-one (not even Deutsche IMO) yet knows what the damage would be.

You’ve mixed up gross derivative notional with exposure.  

For example if I was Deutsche Bank and I lent €100m to VW, I have a €100m exposure to VW. If VW decides it wants to borrow fixed I’d sell them an interest rate derivative for a €100m notional which converts their floating rate loan payment into fixed.

That €100m interest rate derivative has a notional of €100m but my exposure is dependent on present valuing that derivative. If interest rates fall then that derivative has a positive MTM to Deutsche Bank whilst if interest rates rise that derivative has a negative value. From a counterparty exposure perspective it’s only the positive MTM I’m concerned with (the MTM is the present value over the lifetime of the trade, so if VW go under the trade will be torn up and I won’t receive those future cash flows). With a negative MTM if VW goes under the trade also gets torn up but DB would simply hand over the present value to VW. 

Essentially it’s the MTM which is important when it comes to derivatives exposure not the underlying notional, which is a red herring.

 

[JMD]

22 minutes ago, Tdog said:

Deutsche has to be the reason Germany aka the EU is so desperate for the deal to be ratified as arent i right in thinking it puts Britain on the hook for its bailout.

I have also heard something similar, but my understanding is that... the so-called 'withdrawal agreement' signs us (the UK) up to bailing out EU institutions if its needed, for the next 25 years... so along with the expected very-very protracted 'transition' period (2 years++?), I expect we shan't really be leaving the EU in any meaningful sense. Regarding Deutsche Bank, although its not an EU institution, financial contagion etc will ensure ECB pain, and so France/Germany/UK will have to pick up the pieces.

This is in the Boris-May deal, not that the politicians, experts or media have bothered to tell us. So if a financial collapse does happen, I would expect a lot of angry voters. Just as well we aren't due another election until 5-years after next month's one.  

   

 

[JMD]

Thanks everyone for all the suggestions/discussion over the last few days regarding the riskier/junior miners. I am now in the process of drawing-up my own shortlist.

The Australian miner - Vista Gold was mentioned. I am looking for similar Australian miners and found De Grey Mining, Silver Lake Resources, Silver Mines. Are these held by anyone, or if you know of alternatives to these, I would appreciate hearing about them.     

[Majorpain]

1 hour ago, Castlevania said:

You’ve mixed up gross derivative notional with exposure.  

For example if I was Deutsche Bank and I lent €100m to VW, I have a €100m exposure to VW. If VW decides it wants to borrow fixed I’d sell them an interest rate derivative for a €100m notional which converts their floating rate loan payment into fixed.

That €100m interest rate derivative has a notional of €100m but my exposure is dependent on present valuing that derivative. If interest rates fall then that derivative has a positive MTM to Deutsche Bank whilst if interest rates rise that derivative has a negative value. From a counterparty exposure perspective it’s only the positive MTM I’m concerned with (the MTM is the present value over the lifetime of the trade, so if VW go under the trade will be torn up and I won’t receive those future cash flows). With a negative MTM if VW goes under the trade also gets torn up but DB would simply hand over the present value to VW. 

Essentially it’s the MTM which is important when it comes to derivatives exposure not the underlying notional, which is a red herring.

 

However the notional value is set in stone and is 100% correct, it is therefore a good metric IMO to getting a reasonable idea as to the banks total liability and how leveraged they are.   The actual profit and loss can be done by the banks internal model, mainly due to there being no market for some of the contracts, and as CDO's in the past showed banks marking their own homework has not ended well.   Mark to market is great if the market is functioning and you can get a price, less so if everyone else shuts up shop and your the one left holding notional billions/trillions of toxic crap (2008 again).  

Using your scenario, if Deutsche screwed up and was 5% off its a 5m Euro loss, if they screw up at 5% on $53 trillion its a helluva lot of money.  They dont owe $53 trillion, but with the leverage involved its a very slim margin of error, and even with loss limiting contracts its enough to get me worried.

[Democorruptcy]

8 minutes ago, Majorpain said:

However the notional value is set in stone and is 100% correct, it is therefore a good metric IMO to getting a reasonable idea as to the banks total liability and how leveraged they are.   The actual profit and loss can be done by the banks internal model, mainly due to there being no market for some of the contracts, and as CDO's in the past showed banks marking their own homework has not ended well.   Mark to market is great if the market is functioning and you can get a price, less so if everyone else shuts up shop and your the one left holding notional billions/trillions of toxic crap (2008 again).  

Using your scenario, if Deutsche screwed up and was 5% off its a 5m Euro loss, if they screw up at 5% on $53 trillion its a helluva lot of money.  They dont owe $53 trillion, but with the leverage involved its a very slim margin of error, and even with loss limiting contracts its enough to get me worried.

Surely the $53 Trillion has a lot netted off? In simple terms they might have $1 trillion short something but a $1 trillion long the same thing. Their exposure isn't $2 Trillion, it's the margin between the long and short derivative. If so 5% of that is nowhere near as much as 5% of $2 Trillion.

[Democorruptcy]

19 hours ago, MvR said:

Yes.. the point for me is to be able to trade everything in one account without delay, and to be able to hedge efficiently with different instruments in the same account.

 Multi-currency margin accounts also work differently to regular single currency cash accounts in that when you buy something in a foreign currency, you don't convert currency to make the trade. Hence no currency conversion costs. You just end up with a negative balance in the foreign currency. When you sell again the sale proceeds pay off the negative currency balance ( plus or minus any profit or loss on the trade ). Very useful if you're constantly trading foreign instruments as I am. ( Not that currency conversion is expensive in Interactive Brokers. The bid/offer spread is measured in fractions of a penny and the commission is around a dollar a trade. )

I prefer US markets for most things because they are so liquid, commissions tend to be lower, and most of the instruments I want to trade are only available on US exchanges.

Sorry to labour the point but I still don't get it. It seems like you are saying the currency fluctuation has no effect. Can we put some figures to it?

Say I have £20,000 in the account and GBP/USD is 1.25, I buy $10,000 in UST. Later on I sell all the UST when GBP/USD is 1.50. Say the UST price is the same when I buy and sell. At the end what has my balance become after the two transactions and any other charges? 

 

 

[Majorpain]

1 minute ago, Democorruptcy said:

Surely the $53 Trillion has a lot netted off? In simple terms they might have $1 trillion short something but a $1 trillion long the same thing. Their exposure isn't $2 Trillion, it's the margin between the long and short derivative. If so 5% of that is nowhere near as much as 5% of $2 Trillion.

Very possibly, but to the best of my knowledge and research they don't disclose that info for commercial reasons so calculating the true figure would be impossible for us normal people. The ECB didnt put a value some of the more complex contracts in the past, because (in their words) they didnt understand them, and the only people who did were Goldman and Morgan Stanley who designed them and were competing on it so couldn't!  Thats the sort of thing that gets alarm bells ringing for me.

[MvR]

4 minutes ago, Democorruptcy said:

Surely the $53 Trillion has a lot netted off? In simple terms they might have $1 trillion short something but a $1 trillion long the same thing. Their exposure isn't $2 Trillion, it's the margin between the long and short derivative. If so 5% of that is nowhere near as much as 5% of $2 Trillion.

That's the theory... although it relies on the counter-party being solvent and able to cover it's obligations. Only insiders can know the true picture, and quite possibly they don't know either.

I know a tech person who was contracted in to Anglo-Irish bank to help them query their databases / loan books during the credit crunch to see where exactly where they stood. I heard, unofficially, that they were fine. A month or two later they collapsed, since a lot of the dodgy stuff wasn't entered into the system.

[Castlevania]

39 minutes ago, Majorpain said:

However the notional value is set in stone and is 100% correct, it is therefore a good metric IMO to getting a reasonable idea as to the banks total liability and how leveraged they are.   The actual profit and loss can be done by the banks internal model, mainly due to there being no market for some of the contracts, and as CDO's in the past showed banks marking their own homework has not ended well.   Mark to market is great if the market is functioning and you can get a price, less so if everyone else shuts up shop and your the one left holding notional billions/trillions of toxic crap (2008 again).  

Using your scenario, if Deutsche screwed up and was 5% off its a 5m Euro loss, if they screw up at 5% on $53 trillion its a helluva lot of money.  They dont owe $53 trillion, but with the leverage involved its a very slim margin of error, and even with loss limiting contracts its enough to get me worried.

I disagree. It’s the MTM that you should focus upon. If that MTM is wrong by 5% then so be it, but the MTM probably isn’t 5% of the notional to begin with.

A further problem with simply using the notional is that the dealer banks will hedge their market risk. So in my example above they’d hedge that risk with an offsetting derivative with another counterparty. They now have two derivatives with a combined notional of €200m, but the cash flows largely offset. The risk will be from the counterparties defaulting not the market risk. You can even mitigate the credit risk by posting daily collateral.

Anyhow if a bank is to go under I think it will be due to credit losses on their lending. 

[MvR]

1 hour ago, Democorruptcy said:

Sorry to labour the point but I still don't get it. It seems like you are saying the currency fluctuation has no effect. Can we put some figures to it?

Say I have £20,000 in the account and GBP/USD is 1.25, I buy $10,000 in UST. Later on I sell all the UST when GBP/USD is 1.50. Say the UST price is the same when I buy and sell. At the end what has my balance become after the two transactions and any other charges? 

No problem. The key thing to remember is that you can store multiple currencies in a single account, and you can have a negative currency balance too. ( a bit like an overdraft ).

So to start with :-

1.  GBP balance = £20,000,   USD balance = $0,  Bond Inventory = $0.   Net Liquidation Value of the account in Sterling is £20,000

Assume the commission to buy or sell the Treasury bonds is $7.50 each way.

2. You then buy the bonds, which are paid for in dollars borrowed from your broker.  You also pay the $7.50 commission. 

Now your GBP balance = £20,000,  USD balance = minus $10,007.50 ,  Bond Inventory = $10,000.  

At the 1.25 exchange rate, the minus $10,007.50 balance is worth minus £8,006, and the Treasury Bonds are worth £8,000

3. Time passes. You rack up $50 dollars in interest on the $10,000 "loan" borrowed from your broker.  This is deducted from your dollar balance. The exchange rate has now moved to 1.50.  

GBP balance still = £20,000,  USD balance now = minus $10,057.50, Bond Inventory is still $10,000.  

At the 1.5 exchange rate, the minus $10057.50 balance is now worth minus £6705 and the Treasury Bonds are now worth £6,666.67.  The currency fluctuation has decreased the value of the bonds is GBP terms, but it has also decreased the value of your dollar debt too. i.e. they balance each other out.

4. You sell the bonds, paying another $7.50 commission.  Your GBP balance still = £20,000. USD balance now = minus $ 65 ( two lots of commissions and the $50 interest paid ), Bond inventory = $0.

Your ending GBP balance is still £20,000, and the minus $65 is worth minus £43.33. I wouldn't bother closing this negative balance out as it would cost a dollar to do the trade and won't be racking up much interest.

So now Net Liquidation Value is £20,000 - £43.33 = £19,956.67.  Since all the trading was in dollars, the £20,000 sterling was never touched.

So no profit was made.. in fact it's a small loss, but that's not the point of the trade. if the Broker had gone bust during the period you were holding the bonds,  the Fed / US Treasury would recognise the bonds were in your name, and pay you your $10,000 dollars back when they mature.

Obviously at this scale, there's not much point, but since the the US equivalent of the FSA protection in brokerage accounts is around $50,000 ( I think? ), it might be worth it to protect larger cash sums.  In practice, the Fed has historically guaranteed larger sums for retail traders, but one can't be sure they'd do it again.

In the case of Interactive Brokers, the UK FSA limit applies, since they have a UK subsidiary, so any cash balance significantly over the limit could be worth protecting this way. That's my reason for learning this stuff anyway, even though my account isn't that large.. yet... here's hoping though!