Pricing Money: A beginner's guide to money, bonds, futures and swaps • Hacker News Board

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#51

Post by pwatsonwailes » Fri, Jun 16, 2023, 8:52 PM UTC

Utkarsh_Mood wrote: post #50

pwatsonwailes wrote: post #39

Earlier quoted context omitted.

Sure. You mitigate risk on speculation by hedging. I'll try and give a similarly simple (if not perfectly accurate and far more lengthy) explanation. Someone mentioned farming financials in the comments around this, so we'll use that. It's also something I know well, as I know a lot of farmers. Let's imagine that a commercial farmer, whom we'll call Jeremy plants 100 acres of wheat on a farm. Market values for wheat…

> On the other hand, if he's a good farmer, and the farm produces well, and he doesn't over-extend his risk on what he's committing to, he now has a fixed price contract for his goods, which isn't going to fluctuate based on time (assuming the contract is honoured - if he's worried about that, Jeremy could then buy insurance on the risk of a default on the contract So basically a third party would step in to assure h…

I mean, shit is still going to hit the fan if the contract isn't honoured, but in the simplest terms, yes, he'll still get paid by the insurer if the contract party defaults on the contract. (As a massive scale version of this, see 2007/2008 financial crash. That's basically what happens when counterparties default at scale and insurance contracts have to pay out everywhere, to the level that the insurers themselves have to be rescued.)

Simple example - let's say the contract is for 100 tonnes of wheat at £175 a tonne. So Jeremy should get £17,500 for the wheat he's contracted to deliver. Now let's say that Jeremy has the 100 tonnes ready to go, but the flour merchant can't/won't pay up. Maybe he's in financial troubles, maybe Jeremy ran off with his wife, who knows. But for whatever reason, he refuses to pay.

Now let's also imagine two scenarios - one in which the price of wheat has gone up, and one where it's gone down. In the former, Jeremy is actually happy with this, as he can now sell his grain on the open market for more than the contract, and claim the insurance payout on the contract. On the other hand, if the price went down, Jeremy still has to sell his grain, but he might only get £100 a tonne, which is going to result in a loss of £7,500. At this point Jeremy is very glad of the insurance.

Now the interesting bit is the insurer has the estimate the risk of default, and the likely movement on the market, to be able to offer a sensible insurance product to Jeremy. So Jeremy might pay £1,000 for an insurance product which pays out £10,000 on the default of the purchaser, for example. Obviously the numbers involved here are fictional (apart from the price of wheat per tonne, which is probably around the mark given at the moment), but the principle is accurate.

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#52

Post by MR4D » Fri, Jun 16, 2023, 8:52 PM UTC

panarchy wrote: post #38

lolpython wrote: post #24

Earlier quoted context omitted.

Farmers use futures contracts to protect against price risks [0]. As do energy suppliers [1]. [0] https://www.ers.usda.gov/webdocs/publications/99518/eib-219.... [1] https://emp.lbl.gov/publications/primer-electricity-futures-...

Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples? What percentage of futures trading is on farmers crops? What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death? How well will it work if we create unsustainable land that…

Because farmers have been using futures contracts (traded on an exchange) since 1859.

And technically, futures are a more standardized tool than forwards are, hence the talk about futures all the time. [1] For reference, forwards have been used forever, and used for all sorts of commerce. [2]

We take for granted that you can pull out an iPhone and buy your favorite stock in seconds, but for most of history, nobody could even imagine that. That the modern world even exists is because of forwards and futures. The ancient world was able to grow and expand because of forwards.

[0] - https://www.cftc.gov/About/HistoryoftheCFTC/history_precftc....

[1] - https://www.investopedia.com/ask/answers/06/forwardsandfutur...

[2] - https://www.encyclopedia.com/social-sciences/applied-and-soc...

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#53

Post by alphanullmeric » Fri, Jun 16, 2023, 8:53 PM UTC

tech_ken wrote: post #17

This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?

Sounds like you worry too much about what other people do with their own time and money.

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#54

Post by pwatsonwailes » Fri, Jun 16, 2023, 8:58 PM UTC

criddell wrote: post #48

lordnacho wrote: post #21

Earlier quoted context omitted.

The arbitrage game keeps the prices consistent with each other. It serves to create liquidity so that participants can get their business done without either waiting too long or paying too much.

Maybe this is a dumb question, but who are the participants? What is the business they need to get done? What are they waiting on?

Not dumb at all. The participants are basically everyone in the market. Everyone buying and selling and speculating on the thing in question.

What they might be waiting on - imagine you have a business wanting to invest in something - new equipment maybe, or opening a new office. That requires capital expenditure. You might not have the free capital to be able to do that. However, if you can improve your cash position, that might be something which becomes available sooner, allowing you to grow more rapidly.

That requires that you're able to secure finance, which means you need someone to either buy something from you now, or to buy the promise of something for the future. In either case, you now have increased cash at bank, which lets you invest to generate returns (hopefully).

This is deeply rooted in the idea that money you have now is worth more than money you may have in the future.

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#55

Post by marcosdumay » Fri, Jun 16, 2023, 9:00 PM UTC

panarchy wrote: post #38

lolpython wrote: post #24

Earlier quoted context omitted.

Farmers use futures contracts to protect against price risks [0]. As do energy suppliers [1]. [0] https://www.ers.usda.gov/webdocs/publications/99518/eib-219.... [1] https://emp.lbl.gov/publications/primer-electricity-futures-...

Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples? What percentage of futures trading is on farmers crops? What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death? How well will it work if we create unsustainable land that…

The one goal of future contracts is for producers and consumers to be able to make deals before that production and consumption happens. Those are the primary dealers there, and I don't really remember where I got statistics, but AFAIK, they are about 10% of the volume.

On top of those primary deals, a lot of people pile up making bets on secondary deals. Those are the people going for "hey, a lot more farms are growing rice this year, I bet its price will fall". They are very welcome because they not only stabilize the prices on those markets, but they also provide short-term money to make the deals flow more homogeneously. Without them, making deals on those markets would be a profession by itself (as it was).

Now, there exist people making bets on the results of the bets of the secondary market. That is a different market. At some point it's clear that this becomes toxic, but nobody seems to agree on what point exactly.

> What about the crops they destroy because they would be less profitable?

You mean farmers getting bankrupt? You seem to be misunderstand, because the main reason farmers love the futures market is because it lowers their risks.

> How well will it work if we create unsustainable land that the farmers can no longer grow crops on?

Well, surely if you go and kill everybody, there will be nobody losing money on those markets.

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#56

Post by JackFr » Fri, Jun 16, 2023, 9:00 PM UTC

tech_ken wrote: post #17

This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?

Not sure if you meant “money market” as it’s understood to be the market lending/borrowing for terms of less than a year, or if you were referring to fixed income markets in general.

Either way it’s hardly a waste of time or money, and banks make money not from “arbitrage shell games” but by matching buyers with sellers. Some people have money to lend and sone people have enterprises they need to fund.

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#57

Post by raincom » Fri, Jun 16, 2023, 9:03 PM UTC

pwatsonwailes wrote: post #22

tech_ken wrote: post #17

This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?

Whilst arbitrage is certainly something which exists in the financial markets, the vast majority of what's done isn't arbitrage. Arbitrage assumes differing views on valuation of an asset today . So I can buy something from person A, which they believe to be worth value x, and sell it to person B, who believes it to be worth y, where y > x. That's arbitrage in its simplest form - the market has priced something incor…

Commodities, homes, lands, water, minerals, etc (let’s call them real assets) can not inflated as freely as possible, the way money can be expanded/inflated. That’s the large source of speculation. This is why people borrow in order to acquire real assets.

Third world countries want to issue debt in American dollars, because no one wants to buy their bonds in their home currencies.

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#58

Post by zzbn00 » Fri, Jun 16, 2023, 9:03 PM UTC

tech_ken wrote: post #17

This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?

One example which is applicable to majority of the working population: in the UK at least the fixed-rate mortgages are priced off the Swap rates as that is how banks hedge them.

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#59

Post by dataflow » Fri, Jun 16, 2023, 9:03 PM UTC

lolpython wrote: post #24

tech_ken wrote: post #17

This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?

Farmers use futures contracts to protect against price risks [0]. As do energy suppliers [1]. [0] https://www.ers.usda.gov/webdocs/publications/99518/eib-219.... [1] https://emp.lbl.gov/publications/primer-electricity-futures-...

I get why farmers do it but what's the societal benefit of letting a rando like me buy and sell (i.e. make bets on) such contracts? Do farmers really prefer that random people do this?

Re: Pricing Money: A beginner's guide to money, bonds, futures and swaps

#60

Post by marcosdumay » Fri, Jun 16, 2023, 9:06 PM UTC

ineptech wrote: post #35

rcme wrote: post #19

Earlier quoted context omitted.

Risk management is the product. Surely you agree that a product that reduces risk is worth something, right?

This isn't false but it feels reductive. A financial instrument that allows one to bet on the corn harvest is obviously valuable to the corn farmer, as it allows them to use profits from good seasons to hedge against bad seasons. They're also valuable to people whose business is affected by the corn harvest - cereal manufacturers, say. The problem is that they can also be used by people with no exposure at all who si…

> as it allows them to use profits from good seasons to hedge against bad seasons

It allows corn farmers to grow wheat instead, because he is selling it right now and wheat is more profitable right now.

The main reason why it doesn't go astray and make people hungry is because people that isn't involved in any way can go, study the factors that make wheat more profitable to corn, do their predictions of what will be the case at the point of delivery, and if they predict correctly that the price is wrong they can go and adjust it making a lot of money on the process.