Derivatives The Wild Beast of Finance

When it first published in spring 1998, Derivatives: The Wild Beast of Finance made bold predictions and recommendations for the future of global finance. Alfred Steinherr explained that, without effective risk management, the incredible explosion in the use and value of derivatives could destabilise the entire global market structure. His views and suggested solutions were not universally accepted. And then, suddenly, in the space of a few months many of the inherent dangers he set out became reality - the Asian crisis took a vicious toll on the tiger economies and the Russian bear collapsed, heralding the ultimate destruction of the most celebrated hedge fund of recent years - Long-Term Capital Management. The knock-on effect of the LTCM collapse was so severe that the US Fed was forced to intervene. In this extensively revised paperback edition, Alfred Steinherr brings the story up to date and uses the opportunity to analyse and reflect on the effectiveness of the solutions he offered first time around. Much of the more technical material from the original edition has been removed to produce a highly readable and thought-provoking explanation of the origins and benefits of global finance, while once again assessing the dangers - imagined and real - that still lurk within this fascinating world. Time alone will tell how much heed is taken this time. "Alfred Steinherr has written a fascinating book that examines the role derivatives play in developing the world economy today, and the part they will have in shaping the financial markets of tomorrow.. For practitioners, officials and students alike, Steinherr has provided a lively and informative canter through the world of derivatives." Investors Digest ". a welcome departure from most texts on the topic. Books on derivatives seem either to be ludicrously sensationalist or steeped in higher level mathematics. In contrast, this work by Alfred Steinherr is both accessible and rigorous." Investment Adviser ". will give a useful insight into the relationship between the derivatives market and the wider financial markets to the general reader.. a highly informative read for those who really want to get to grips with what the derivatives markets are all about." The Investor "Steinherr brings a lucid approach to a complex topic with this book [and] has produced a comprehensive overview which manages to combine a readable style with considerable detail and thought-provoking ideas for the future." European Fund ManagerIn den letzten 20 Jahren ist der Derivatehandel regelrecht explodiert. Die Struktur dieser Finanzprodukte wird jedoch zunehmend komplexer; die Beträge werden immer höher. Derivate wurden häufig als die großen Übeltäter identifiziert, die für viele der wohl bekanntesten Finanzkatastrophen, einschließlich der Barings Bank- und ERM Krise, verantwortlich waren. Dies ist die neue, komplett überarbeitete und aktualisierte Broschurausgabe von "Derivatives: The Wild Beast of Finance". Der Inhalt wurde komprimiert und um einige der komplexeren Themen gekürzt. Dadurch wurde diese Ausgabe für Anleger und Finanzinteressierte verständlicher. Steinherr vertritt hier die Ansicht, daß Derivate - wenn man umsichtig vorgeht - ein wirksames und durchaus akzeptables Anlagemittel sind. Darüber hinaus sind sie ideal geeignet, um effektives Risikomanagement in globalen Märkten zu gewährleisten und mögliche Finanzkatastrophen einzudämmen. Preface to the Revised Paperback Edition

Introduction

Part I A Look Back

1 Evolution of Finance

Venice, April 1470

1 The functions of finance

2 The first step towards managing financial risk: diversification and collateral

3 The second step towards managing financial risk: limited liability, bankruptcy laws, seniority rules, balance-sheet structure

4 The third step towards managing financial risk: creating tradable instruments and liquidity in organised markets

5 The final step towards managing financial risk: derivatives and financial engineering

6 Could the acceleration in financial innovation since 1970 have been predicted?

7 Conclusion

Notes

2 The Americanisation of Global Finance

Minnesota Banc Corporation

1 The emergence of the American model of finance

2 The crowning achievement: risk-management finance

3 Maintaining market liquidity: the sine qua non of the "American model"

4 Global finance: the result of exporting the "American model"

5 Conclusion

Notes

3 Dramatic Events

How George Soros sees it

1 The EMS crisis of 1992-93

2 Metallgesellschaft: in the red or in the black?

3 Barings: victim of high-leveraged speculation and loose controls

4 Bankers Trust: caveat emptor

5 David Askin: the fallen star of the mortgage-backed securities sky

6 Instability in emerging markets: Mexican tequila

7 Hedge funds and the collapse of LTCM

8 Conclusion

Notes

Part II Derivatives and Their Markets

4 The Revolution in Risk Management

Farming for the future

1 What can derivatives achieve?

2 Price discovery and volatility

3 Is risk management a fundamental corporate objective?

4 Risk management: science or fad?

5 Risk management: some examples

6 Conclusion

Notes

5 Mutualisation of Risk on Exchanges

Chicago's other side

1 Evolution of exchange-traded financial derivatives

2 Organisation of the exchanges

3 What makes a successful exchange-traded contract?

4 New product developments on the exchanges

5 Exchanges for a global market

6 Conclusion

Notes

6 Customised Risk Management in OTC Markets

How to lose money on a long put when markets crash

1 Market developments

2 Significant bank involvement

3 Contagion risk

4 Regulatory inadequacies for the specificities of OTC markets

5 New developments

6 Conclusion

Notes

Part III Public Policy Options

7 Are Derivatives a Threat to Global Financial Stability?

The global financial crash of October 2002

1 Systemic risk illustrated with the crises in Asia and Russia

2 Derivatives: the dynamite for financial crises

3 Global derivative finance: the fuse for contagion

4 Conclusion

Notes

8 Challenges for the Established Financial Order

The butterflies of finance

1 The classical paradigm of financial policy

2 Paradise lost

3 Reducing systemic risk: the Basle approach

4 Conclusion

Notes

9 A Financial Policy Model for the Next Century

The challenge of global money

1 Reform of the international financial system

2 The architecture for regulatory rethinking

3 Risk management through clearing-houses

4 Phasing out the banking franchise and institutional regulation

5 Redefining the relationship between central banks and financial intermediaries

6 Conclusion

Notes

Part IV A Look into the Future

10 Derivatives: the Future of Finance

Antofagasta (Chile), summer of 2020

1 The ascent of institutional investors

2 Ownership and corporate governance

3 Macro futures

4 Real estate futures

5 The end of banking?

6 Conclusion

Notes

11 Conclusions

1 The origin of the species

2 OTC versus exchange-traded contracts

3 Americanisation of global finance

4 Risk management: one of the most important innovations of the 20th century

5 Work of the devil or social benefit?

6 Financial structure in the 21st century

7 Shifts of power

8 Crystal ball gazing

Glossary

References

Index

"This book is a stimulating read with an excellent overview of risk in banking. It can be recommended to anyone who is interested in banking, derivatives and the regulation of the financial sector." (Times Higher Educational Supplement, 17th November 2000) Alfred Steinherr is General Manager at the European Investment Bank in Luxembourg and Rector of the Free University of Bolzano in Italy. He was responsible for the development of the EIB's risk-management and performance systems and for the design of risk hedging. When it first published in spring 1998, Derivatives: The Wild Beast of Finance made bold predictions and recommendations for the future of global finance. Alfred Steinherr explained that, without effective risk management, the incredible explosion in the use and value of derivatives could destabilise the entire global market structure. His views and suggested solutions were not universally accepted. And then, suddenly, in the space of a few months many of the inherent dangers he set out became reality - the Asian crisis took a vicious toll on the tiger economies and the Russian bear collapsed, heralding the ultimate destruction of the most celebrated hedge fund of recent years - Long-Term Capital Management. The knock-on effect of the LTCM collapse was so severe that the US Fed was forced to intervene. In this extensively revised paperback edition, Alfred Steinherr brings the story up to date and uses the opportunity to analyse and reflect on the effectiveness of the solutions he offered first time around. Much of the more technical material from the original edition has been removed to produce a highly readable and thought-provoking explanation of the origins and benefits of global finance, while once again assessing the dangers - imagined and real - that still lurk within this fascinating world. Time alone will tell how much heed is taken this time. "Alfred Steinherr has written a fascinating book that examines the role derivatives play in developing the world economy today, and the part they will have in shaping the financial markets of tomorrow.. For practitioners, officials and students alike, Steinherr has provided a lively and informative canter through the world of derivatives." Investors Digest ". a welcome departure from most texts on the topic. Books on derivatives seem either to be ludicrously sensationalist or steeped in higher level mathematics. In contrast, this work by Alfred Steinherr is both accessible and rigorous." Investment Adviser ". will give a useful insight into the relationship between the derivatives market and the wider financial markets to the general reader.. a highly informative read for those who really want to get to grips with what the derivatives markets are all about." The Investor "Steinherr brings a lucid approach to a complex topic with this book [and] has produced a comprehensive overview which manages to combine a readable style with considerable detail and thought-provoking ideas for the future." European Fund Manager