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Durbin, All About Derivatives

  
  Education
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All About Derivatives (McGraw-Hill, 2011, a fully revised second edition) is a curious book, and I don’t say that unkindly. It’s just odd that in a book in the “All About” series, touted as “the easy way to get started,” you find such a lengthy discussion of options pricing. But then Michael Durbin is, among other things, a financial technology consultant specializing in high-frequency trading of financial derivatives, and he has helped numerous Wall Street firms develop derivative pricing and trading systems.

The structure of this book is straightforward. After an overview chapter, the author devotes a chapter each to forwards, futures, swaps, options, and credit derivatives. He then looks at using derivatives to manage risk, pricing the various derivatives, hedging a derivatives position, and derivatives and the 2008 financial meltdown. In three appendices he investigates interest, swap conventions, and binominal option pricing.

Even though this book would be a fine introduction to the subject of derivatives, it often goes beyond the elementary. For instance, Durbin points out the subtle pricing differences between warrants and options. Moreover, the book is laced with interesting tidbits. I didn’t know, for example, that Enron issued a series of credit-sensitive notes in 1998 that offered a coupon rate inversely tied to its credit rating. (more…)

Rogoff Sees Sovereign Defaults

  
Economy, Education
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rogoff01

Feb. 24 (Bloomberg) — Ballooning debt is likely to force several countries to default and the U.S. to cut spending, according to Harvard University Professor Kenneth Rogoff, who in 2008 predicted the failure of big American banks.

Following banking crises, “we usually see a bunch of sovereign defaults, say in a few years,” Rogoff, a former chief economist at the International Monetary Fund, said at a forum in Tokyo yesterday. “I predict we will again.”

The U.S. is likely to tighten monetary policy before cutting government spending, sending “shockwaves” through financial markets, Rogoff said in an interview after the speech. Fiscal policy won’t be curbed until soaring bond yields trigger “very painful” tax increases and spending cuts, he said.

Global scrutiny of sovereign debt has risen after budget shortfalls of countries including Greece swelled in the wake of the worst global financial meltdown since the 1930s. The U.S. is facing an unprecedented $1.6 trillion budget deficit in the year ending Sept. 30, the government has forecast.

“Most countries have reached a point where it would be much wiser to phase out fiscal stimulus,” said Rogoff, who co- wrote a history of financial crises published in 2009. It would be better “to keep monetary policy soft and start gradually tightening fiscal policy even if it meant some inflation.”

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Roubini: How to prevent a depression

  
Analysis, Education
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An eight point plan to minimise the fallout of another economic contraction.

AMSTERDAM – The latest economic data suggests that recession is returning to most advanced economies, with financial markets now reaching levels of stress unseen since the collapse of Lehman Brothers in 2008. The risks of an economic and financial crisis even worse than the previous one – now involving not just the private sector, but also near-insolvent sovereigns – are significant. So, what can be done to minimize the fallout of another economic contraction and prevent a deeper depression and financial meltdown?

First, we must accept that austerity measures, necessary to avoid a fiscal train wreck, have recessionary effects on output. So, if countries in the eurozone’s periphery are forced to undertake fiscal austerity, countries able to provide short-term stimulus should do so and postpone their own austerity efforts. These countries include the United States, the United Kingdom, Germany, the core of the eurozone, and Japan. Infrastructure banks that finance needed public infrastructure should be created as well.

Second, while monetary policy has limited impact when the problems are excessive debt and insolvency rather than illiquidity, credit easing, rather than just quantitative easing, can be helpful. The European Central Bank should reverse its mistaken decision to hike interest rates. More monetary and credit easing is also required for the US Federal Reserve, the Bank of Japan, the Bank of England, and the Swiss National Bank. Inflation will soon be the last problem that central banks will fear, as renewed slack in goods, labor, real estate, and commodity markets feeds disinflationary pressures. (more…)

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