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Stripping away the disguise of derivatives
By Satyajit Das
Published: February 17 2010 14:37 | Last updated: February 17 2010 14:37
Reaction to revelations that Greece used derivatives to disguise its true level of borrowing is reminiscent of Captain Renault (played by Claude Rains) in Casablanca: “I am shocked, shocked to find that gambling is going on in here.”
Use of derivatives to disguise debt and arbitrage regulations and accounting rules is not new. In the 1990s Japanese companies and investors pioneered the use of derivatives to hide losses – a practice called “tobashi” – “to make fly away”.
Derivatives, such as interest rate and currency swaps, are used to alter the interest rates and currency of the cash flows on existing assets or liabilities. Transactions entail exchanges of one stream of payments for another. At the commencement of the transaction, if the contract is priced at current market rates, then the current (present) value of the two sets of cash flows should be equal (ignoring any profit). The contract has “zero” value – in effect, no payment is required between the parties.
Using artificial “off-market” interest or currency rates, it is possible to create differences in value between payments and receipts. If the value of future payments is higher than future receipts, then one party receives an upfront payment reflecting the now positive value of the contract. In effect, the participant receives a payment today that is repaid by the higher-than-market payments in the future. Any number of strategies involving combinations of different derivatives can achieve this effect.
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The Greek transactions are believed to be similar cross-currency swaps linked to the country’s foreign currency debt, structured with off-market rates. Analysts suggest that the cash received from the transactions may have reduced Greece’s debt/GDP ratio from 107 per cent in 2001 to 104.9 per cent in 2002 and lowered interest payments from 7.4 per cent in 2001 to 6.4 per cent in 2002.
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http://www.ft.com/cms/s/0/270fb2b6-1...44feab49a.html
Doesn't sound like much
By Satyajit Das
Published: February 17 2010 14:37 | Last updated: February 17 2010 14:37
Reaction to revelations that Greece used derivatives to disguise its true level of borrowing is reminiscent of Captain Renault (played by Claude Rains) in Casablanca: “I am shocked, shocked to find that gambling is going on in here.”
Use of derivatives to disguise debt and arbitrage regulations and accounting rules is not new. In the 1990s Japanese companies and investors pioneered the use of derivatives to hide losses – a practice called “tobashi” – “to make fly away”.
Derivatives, such as interest rate and currency swaps, are used to alter the interest rates and currency of the cash flows on existing assets or liabilities. Transactions entail exchanges of one stream of payments for another. At the commencement of the transaction, if the contract is priced at current market rates, then the current (present) value of the two sets of cash flows should be equal (ignoring any profit). The contract has “zero” value – in effect, no payment is required between the parties.
Using artificial “off-market” interest or currency rates, it is possible to create differences in value between payments and receipts. If the value of future payments is higher than future receipts, then one party receives an upfront payment reflecting the now positive value of the contract. In effect, the participant receives a payment today that is repaid by the higher-than-market payments in the future. Any number of strategies involving combinations of different derivatives can achieve this effect.
...
The Greek transactions are believed to be similar cross-currency swaps linked to the country’s foreign currency debt, structured with off-market rates. Analysts suggest that the cash received from the transactions may have reduced Greece’s debt/GDP ratio from 107 per cent in 2001 to 104.9 per cent in 2002 and lowered interest payments from 7.4 per cent in 2001 to 6.4 per cent in 2002.
..
http://www.ft.com/cms/s/0/270fb2b6-1...44feab49a.html
Doesn't sound like much