[HN Gopher] Pricing Money: A beginner's guide to money, bonds, f...
___________________________________________________________________
Pricing Money: A beginner's guide to money, bonds, futures and
swaps
Author : mhh__
Score : 296 points
Date : 2023-06-16 15:54 UTC (7 hours ago)
(HTM) web link (www.jdawiseman.com)
(TXT) w3m dump (www.jdawiseman.com)
| jrockway wrote:
| This is really interesting. Very early in my career I worked on a
| team that supported the interest rate swaps desk at a large
| investment bank. Not one person told me to read this book. I
| still don't know what they are. Wish I read this back then!
| dang wrote:
| (This comment is just a stub so I can bundle a bunch of obsolete
| subthreads about a former typo in the URL)
| politician wrote:
| @mhh__ Link 404's.
| AnimalMuppet wrote:
| 404.
|
| 9 upvotes for the post currently, though, which I have a hard
| time seeing with a bad URL. Maybe they removed it when traffic
| spiked?
| mhh__ wrote:
| I commented it elsewhere with the correct link (but it's good
| enough to deserve its own post so here it is but I posted the
| link on my phone so something got borked)
| turtleyacht wrote:
| 404
|
| The link had extra periods at the end. Edited, the page loads
| fine:
|
| http://www.jdawiseman.com/books/pricing-money/Pricing_Money_...
| dang wrote:
| Fixed now. Thanks!
| mhh__ wrote:
| Yes, my phone's clipboard has betrayed me. I've emailed dang
| mhh__ wrote:
| This link is right. Don't think I can edit the submission's URL
| (@dang ?) http://www.jdawiseman.com/books/pricing-
| money/Pricing_Money_...
| dang wrote:
| Fixed now. Thanks!
| tc313 wrote:
| It's hard to put a date on it, but surely it's no more recent
| than (2021).
| dizzydes wrote:
| I love it. That said, I'd love to see an updated version with QE
| as that has a gigantic effect in recent times.
|
| For simplicity it can be thought of as a proxy to interest rate
| adjustments but how it works is complex and can lead to strange
| side effects.
| dang wrote:
| Related ongoing thread:
|
| _Probability and Markets [pdf]_ -
| https://news.ycombinator.com/item?id=36354259 - June 2023 (60
| comments)
| nodesocket wrote:
| This looks like an amazing resource. The problem I have is
| digesting all the information and financial/mathematical data. I
| tend to get overwhelmed by densely rich books and sort of tune
| out as I read.
| hartator wrote:
| Would love to be able to buy a printed copy.
| 0xcafefood wrote:
| On a related note: does anyone have good recommendations for
| printing services that can print and bind an online PDF, etc?
| I've looked into lulu.com and printme1.com but haven't used
| either for this purpose.
|
| I've wanted to do something similar for some of Beej's guides
| that are not in regular print, and would definitely consider
| for this too.
| Nzen wrote:
| I looked at lulu for printing Scott Alexander's Unsong. Their
| terms of service declaim [0] anyone looking to print content
| that they do not have copyright or a license for. That's the
| entire point of copyright.
|
| I recommend that you contact beej directly.
|
| [0] https://www.lulu.com/terms-and-conditions section 3
| paragraph 3
| howard941 wrote:
| Most local printing places (places that do business cards,
| flyers, and the like) will gladly supply a quote for a single
| printed and bound PDF. Last time I did this only had to send
| the PDF for a complex flight sim. Shop local!
| SnooSux wrote:
| I had a college course use Lulu to print the notes into a
| textbook. The quality was good for a paperback. I think
| you're limited to black and white though. The formatting of
| the TeX notes could have been better, but that's probably on
| the professor to have fixed.
| Nzen wrote:
| Um, the second paragraph has a link [0] to Wiley's page for it,
| which only offers a paperback edition.
|
| [0] https://www.wiley.com/en-
| us/Pricing+Money:+A+Beginner's+Guid...
| robocat wrote:
| Para says (with links): While stocks last,
| hard copies of Pricing Money can still be purchased from
| Wiley, Waterstones, Amazon.co.uk, Amazon.com, Amazon.fr,
| Amazon.de, Amazon.co.jp, Abe books, as well as other
| bookshops: cite ISBN 0-471-48700-7
| dotBen wrote:
| I would love to buy an eBook version of it. That isn't the $75
| Kindle version on Amazon.
| gretch wrote:
| I read a couple of pages and it looks good. I'm not a complete
| beginner but it's still filling in some gaps in my knowledge. I
| appreciate the author's work and giving it away for free.
|
| That said I feel like it's skipping some explanation for what's
| supposed to be a beginner's guide. One thing that sticks out to
| me is that it jumps straight into talking about interest rates
| without explaining the time value of money and why interest
| exists.
|
| I wanted a book I could recommend and to others who knew even
| less than me, but I don't think this could be it.
|
| (And maybe interest is covered later on, but the ordering is
| important)
| tech_ken wrote:
| 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?
| yieldcrv wrote:
| > How is this more than an abysmal waste of time and resources
| simply to make a small handful of bankers richer?
|
| Interesting observation given that your own wealth is managed
| this way.
|
| Whether its the simple bank deposit in a checking account, if
| you've ever chased an interest rate for a savings account, or
| had your earnings managed in a retirement account from your
| employer, or if you attempted to make money faster because a
| debt was coming due.
|
| Its all tied together and a product of this system.
|
| The goal is to keep money moving within the economy, as people
| also race to hoard it.
| JackFr wrote:
| 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.
| lend000 wrote:
| The output (generally speaking, not specific to money markets)
| is better prices. There are large scale examples of economies
| in which prices were mismanaged either due to lack of
| information/technology or centrally planned prices, some of
| which resulted in failed states (e.g. Venezuela and the Soviet
| Union). While providing market information signals via prices
| is certainly an abstract concept that most people will never
| appreciate, it is important regardless.
|
| For complex instruments in money markets, the main effects are
| bridging mis-priced treasuries on different time frames and
| hedging against various outcomes for pensions, banks, and
| dealers in physical commodities.
|
| Most of the complex stuff either serves one of those purposes
| or becomes a zero sum game that doesn't affect non-
| participants. It's important to judge each instrument by its
| purpose and mechanism rather than bunch everything as a way to
| make bankers richer (e.g. a future vs. a CDO).
| mhh__ wrote:
| CDOs aren't particularly crazy until you start pricing them
| using completely fictitious numbers and reasoning (IMO at
| least).
| novosel wrote:
| Great questions, but no reply will be coming at you.
|
| Except an apologetic nonsense-logic-it-is-obvious-it-works
| trope.
|
| Only product is the profit.
| scubbo wrote:
| Quite. The general response I get from questions like this to
| financial folks is that these markets and vehicles and
| products are important "for liquidity", but they can never
| quite tell me who liquidity benefits other than the system
| itself.
| NoboruWataya wrote:
| It benefits people who need to raise cash, because they can
| do it more quickly and generally with lower financing costs
| than in an illiquid market.
|
| It benefits people who have cash that they want to invest,
| because they have more opportunities to do it and more
| visibility over which investments are safe and which ones
| are risky.
|
| Therefore it benefits society by transferring cash from
| people who have it now but need it later, to people who
| will have it later but need it now. Enabling and
| facilitating actual socially good activity, like
| manufacturing goods, providing services, etc.
|
| So there are definitely benefits to people outside the
| finance industry. However, in order to accept any of that
| you do ultimately need to believe, to some extent, in the
| market as a means of allocating resources. You don't need
| to think it's perfect, or that it shouldn't be regulated,
| or even that it is the fairest system, but you need to
| accept that it is the system we use. In a totally state-
| planned economy, finance wouldn't work or even make sense.
| esotericimpl wrote:
| [dead]
| zzbn00 wrote:
| 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.
| bell-cot wrote:
| These days - figure that it is 1% "honest & productive uses",
| and 99% society-undermining casino.
| rcme wrote:
| Risk management is the product. Surely you agree that a product
| that reduces risk is worth something, right?
| ineptech wrote:
| 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 simply want to bet on the corn harvest, and from the
| scale of the finance sector it seems like we are pouring a
| lot more of our resources and brainpower in to designing
| exotic new ways to bet on the corn harvest than we are on
| growing corn.
| marcosdumay wrote:
| > 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.
| ineptech wrote:
| I'm not sure how this is related to my post so perhaps I
| was unclear. I'm not talking about individual corn
| farmers and the choices they make, I'm talking about how
| we as a society and an economy allocate our resources.
| I'm saying that derivative financial instruments have
| value, for the reasons I suggested and the others
| described by sibling commenters, but that the finance
| sector is larger than that value warrants.
|
| I'm not sure why I'm being downvoted, as I didn't think
| this is all that controversial. Historically, finance was
| a much more boring and less lucrative field than it is
| now, and consequently much smaller. "I'm a super smart 18
| year old and I want to get rich, so obviously I should go
| into banking" is a relatively recent phenomenon. I agree
| with everyone else here that the industry has value, so
| presumably its recent explosion in size has brought some
| additional value, but it's very hard to believe that
| value is large enough to offset the opportunity cost of a
| generation of ambitious geniuses _not_ going in to
| science or industry or becoming entrepreneurs.
| tech_ken wrote:
| Sure I'm pro-risk management. So by arbing lending-rates
| which risks are mitigated?
| [deleted]
| tylerhou wrote:
| E.g. interest rate risk. Maybe I've sold a bunch of
| variable-rate bonds before. But now I am worried about
| interest rates rising. I can't call the bond for some
| reason (maybe not enough money, maybe some regulatory
| reason). So I buy an interest rate swap that pays out if
| interest rates rise.
| [deleted]
| ulfw wrote:
| Same with the majority of tech companies. All you do is endless
| meetings, plannings, reviews and extremely little actual human
| brain is used for productive output.
| lordnacho wrote:
| 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.
| criddell wrote:
| 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?
| NoboruWataya wrote:
| Ultimately, they are governments, businesses and
| individuals. All of these actors regularly face situations
| where they need (or want) to expend money now that they
| will have eventually but do not have now. The financial
| markets are primarily about making it as efficient as
| possible to do that. (There is arguably another side of the
| financial markets that is about helping people manage risk,
| though they are somewhat related.)
|
| Most of the financial wizardry you read about in the linked
| article is related to that aim. It's not always obvious,
| because a lot of it is higher-order stuff: transactions
| between financial market participants where payouts are
| linked to other transactions (or aggregations of
| transactions) between financial market participants, etc.
| It can be hard to see the link to the participants I
| mentioned above. But a lot of it is a means to
| understanding, and spreading, the risks associated with
| financing those participants. It is a lot easier to lend
| people money to finance their wants and needs if you can
| (a) differentiate between people who will pay you back and
| people you won't; and (b) share the risk of not being paid
| back with others.
| pwatsonwailes wrote:
| 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.
| mhh__ wrote:
| Meaningful prices for the rest of us
| pwatsonwailes wrote:
| 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
| incorrectly, and I can buy it from willing sellers, and sell it
| to willing buyers at different values at the same time.
|
| The vast majority of financial transactions aren't this -
| they're speculative. They bank on the idea that money now is
| worth more than money in the future, and the future value of an
| asset (using the definition of an asset that it's a sequence of
| cashflows) is both variable and uncertain. So therefore the
| promise of future money is inherently tied to the concept of
| risk. The majority of financial markets trading is based around
| this concept of risk, and the management of it.
|
| There's vastly more complexity under the hood, but that's
| roughly speaking, accurate.
| raincom wrote:
| 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.
| tech_ken wrote:
| Gotcha gotcha, that makes sense, thanks for the clear
| explanation! So I can see how the arbitrage (thusly defined)
| has the risk mitigation benefits other people talk about, can
| the same be said about speculation?
| ls612 wrote:
| Speculation is fundamental to price discovery.
|
| Think about it this way, actors in financial markets all
| have various beliefs about the future, and all of these
| beliefs are on a scale of accurate to inaccurate.
| Speculation allows these beliefs to be aggregated into a
| single market price (which btw implies no arbitrage) for
| various types of contingencies and risks, and the price
| will rapidly update to reflect updates to reality and thus
| updates to everyone's beliefs.
| pwatsonwailes wrote:
| 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 (and everything else you can farm, from livestock
| to grains and so on) vary and move constantly, as a
| function of supply and demand. We saw this in an extreme
| form with the invasion of the Ukraine, and the droughts in
| Italy last year.
|
| Now the problem with farming is your timescales are long
| compared to the movements of values for your product in the
| market, so you've no real idea as to what what you're
| planting will be worth by the time the bloody thing has
| actually grown and you've got it harvested and into barns
| to be sold. And once the seed is in the ground, you can't
| exactly just plough it all over and plant something else
| (not strictly accurate, but you don't want to go down that
| route).
|
| So now let's fast forward. Jeremy now harvests his wheat,
| and let's say the price has moved up a lot between planting
| and harvest. Jeremy is a happy man, who's going to have a
| bumper time, even if his crop doesn't produce as much per
| acre as he might like at the minute, because it's not
| raining enough. Or conditions are perfect, and the price
| has gone up, and he makes a huge amount and can reinvest.
| Jeremy is a happy camper.
|
| However, if the price falls, Jeremy is not going to be
| quite so chipper. As such, Jeremy can move his risk,
| through the use of a hedge. Let's say Jeremy hunts around
| to find someone to buy his wheat at the start of the
| season. He might sign a contract with a flour producer,
| stating that they will promise to buy x tonnes of his grain
| at PSy per tonne. Jeremy now has a fixed price, which has
| hedged his risk profile. Now his risk has moved from
| financial to productive - he has to be able to provide the
| x tonnes. If he can't produce it all on the farm, he needs
| to source the difference. 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, but
| that then gets complex). This is a very good thing, but
| means if the market prices his wheat vastly higher than he
| expected, he'll miss out on that upside.
|
| This is called a forward contract. There's other types of
| contract which can be used to do similar things (futures,
| derivatives...) but that gets a bit more complex.
| Utkarsh_Mood wrote:
| > 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 him
| that he'd be paid the fixed price for a small fee? Are
| there no repercussions if the contract isnt honored?
| pwatsonwailes wrote:
| 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 PS175 a tonne. So Jeremy should get PS17,500
| 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
| PS100 a tonne, which is going to result in a loss of
| PS7,500. 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 PS1,000 for an insurance
| product which pays out PS10,000 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.
| TuringTest wrote:
| No, that's purely destructive greed.
|
| Ancient civilizations invented the jubilee (loans should be
| repaid in 7 years) to prevent speculation on them. But
| unfortunately, preventing extreme concentration of wealth
| has fallen out of favour
| tel wrote:
| Arbitrage and it's various squishier more stochastic cousins
| are the vehicle by which information flows through markets.
| Markets exist as a global network of interactions and
| persistent imbalances anywhere in the system can have massive
| consequences. Generally, these consequences rhyme with "two
| counterparties which don't interact with one another directly
| all that often suddenly discover grave disagreements in the
| desired price and quantity of something they'd like to trade".
| Economic wreckage is the result, at least, but also imagine
| what would happen if corn farmers produced only half the crop
| that their buyers would have liked to purchase.
|
| So, markets work pretty hard to make sure that information from
| one area of the global economy can flow to all of the rest of
| the system with relative efficiency. This works a lot like a
| game of telephone where changes in one market venue propagate
| through related instruments to other venues crossing space,
| species, and even time. Much like telephone, each pair of
| neighbors wants to do a good job sharing information without
| loss and, also, over long distances minor errors add up.
|
| Arbitrage is the glue which prevents this from happening.
| Arbitrage says that any time _anyone_ discovers some level of
| disconnection occurring, they can make money at very low risk
| by voting to shift markets to better align with one another.
|
| Arbitrageurs are getting paid to provide a service to the
| market and subsequently the entire world. Their actions ensure
| that information flows throughout the global financial system
| quickly and without relying on centralized planning. Without
| them, markets could become disconnected and wander out of
| agreement.
| lolpython wrote:
| 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-...
| panarchy wrote:
| 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 farmers can no longer grow crops on?
| marcosdumay wrote:
| 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.
| droffel wrote:
| > What about the crops they destroy because they would be
| less profitable?
|
| To clarify this point specifically, food self sufficiency
| is considered a national security issue.
|
| Consider the situation where a hostile country floods
| your market with cheap food products (below cost) until
| your country's farms go bankrupt due to an inability to
| compete. Once you stop producing food of your own, you
| give significant power to whoever controls your food
| supply.
|
| This is a large part of why agricultural subsidies exist.
| And yes, sometimes it means paying farmers to let crops
| rot on the vine in order to not cause market gluts. That
| is an entirely different situation from futures and
| hedging, which in any sane market match supply and demand
| (with the result of minimizing waste).
| nostrademons wrote:
| "floods your market with cheap food products (below
| cost)"
|
| The hostile country will eventually go bankrupt because
| they are producing products below cost.
| hllooo wrote:
| Not necessarily, if they can produce the crops more
| cheaply. Since each country ideally wants to secure it's
| own food supply, it's inevitable that many countries will
| find themselves subsidizing local production that would
| otherwise disappear in a competitive international
| market.
|
| Additionally, hostile countries do not need to flood
| markets sustainably if the goal is simply to hollow out
| food production in the target country before taking more
| overtly hostile (i.e. military) actions.
| tedunangst wrote:
| Ask for an example. Get an example. "That's not the example
| I wanted." Every time.
| OJFord wrote:
| Because that's the origin story.
|
| Other examples are _all_ commodities markets like mining,
| logging, etc.
|
| Of course public company share futures are inherently
| abstract, but they serve similar purposes, just not to a
| particularly similar party, depending on your perspective
| (of ownership, operation).
| cscurmudgeon wrote:
| > Why is it that every time someone mentions futures
| trading
|
| They didn't just mentioned, they had an outsider negative
| take on it.
|
| The best way is to respond with simple examples.
|
| > 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 farmers can no longer
| grow crops on?
|
| How does futures trading cause these negatives? If
| anything, trading reduces these risks. Countries with
| markets have large bounties as opposed to those that don't.
|
| It is not a zero sum game.
| rawgabbit wrote:
| The website gives the gold mine example. Farmers and gold
| miners often have to weigh taking on a loan to get them
| through next season. They want a fixed rate of return to
| determine if the loan is worthwhile.
| dmbche wrote:
| Not sure why this person is getting downvoted, these seems
| like fair questions.
|
| Edit: Now get why it is downvoted, but it's fair to note
| that farmers represent a small (10% from what I gather
| here) portion of futures, so I don't know how
| reprensentative they are.
| pwatsonwailes wrote:
| They don't have anything to do with hedging. Good
| questions, just off-topic, which isn't something HN tends
| to like.
| NoboruWataya wrote:
| I don't have a percentage for you but agriculture-related
| futures make up a non-negligible amount of overall trading.
| It's not just some artificial example. Agricultural futures
| were also the _first_ futures, and much of today 's trading
| infrastructure was built around agricultural futures. So
| that's probably part of why it is such a common example.
|
| They are far from the only example. Airlines use futures to
| hedge against fluctuations in fuel prices. Manufacturers
| use futures to hedge against fluctuations in the price of
| input materials. International businesses use FX swaps to
| hedge against currency fluctuations. Borrowers use interest
| rate swaps to hedge against interest rate rises. Investment
| funds (including pension funds and sovereign wealth funds)
| use options to hedge against drastic movements in asset
| prices.
|
| I don't really understand your other questions. The use of
| derivatives in agriculture does not, on balance, result in
| fewer crops being produced. On the contrary, by allowing
| farmers to protect themselves against various risk,
| derivatives markets allow farmers to safely invest more
| money in production, and reduces the risk of farmers going
| bankrupt (bankrupt farmers don't produce many crops). Food
| would almost certainly be more scarce and more expensive if
| farmers did not have access to the financial markets.
| koolba wrote:
| It's not just farmers. It's useful for anything that
| involves future delivery of a good that could have a
| variable price or production.
|
| A mining company would sell gold futures under the
| expectation that they will mine a known quantity of gold.
| They trade the risk of price fluctuations to match against
| their known liabilities (e.g. labor or depreciation of
| equipment costs).
|
| Now replace "gold" with lithium (for electric car
| batteries) and you can create the greenwashed story that
| you want to hear.
| pdntspa wrote:
| Well, pretty much everybody buying commodities at an
| institutional level are using futures contracts to smooth
| over price risk.
|
| Oil, gas, lithium, corn....
| opportune wrote:
| Because that's what futures are for? Consumers and
| producers of commodities want to lock in prices to lower
| the risk of price fluctuations in the future.
|
| >what about the crops they destroy
|
| This has nothing to do with the discussion
| MR4D wrote:
| 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_p
| recftc....
|
| [1] - https://www.investopedia.com/ask/answers/06/forwardsa
| ndfutur...
|
| [2] - https://www.encyclopedia.com/social-sciences/applied-
| and-soc...
| Quarrel wrote:
| Or since the 18th Century in Japan (and I'm sure other
| places before 1859).
|
| https://en.wikipedia.org/wiki/D%C5%8Djima_Rice_Exchange
| pwatsonwailes wrote:
| Because it's an example you can use to explain a forward
| contract, which is easily understandable as a form of
| hedging risk. Vast amounts of the value of crops are
| hedged, either through forwards, futures or derivatives.
| Crops aren't destroyed because of hedges (in the financial
| sense). Indeed, the whole point is to ensure you don't need
| to, because you've hedged the value of your crop.
|
| I get where you're coming from, and there's a lot which is
| not great in farming, but hedging values isn't one of those
| areas.
| gabereiser wrote:
| >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?
|
| Because it was created by them, for that very purpose?
| Futures Contracts. Chicago Mercantile Exchange. Up until
| 1971 future contracts were ONLY for agricultural goods.
| Quarrel wrote:
| Metal futures have been traded on the London Metal
| Exchange since 1877, and before that at other venues on
| Threadneedle St.
|
| The Dutch (and after the idea had crossed the Channel,
| the English) were trading debt from the invention of
| exchanges.
|
| The CME might have started with FX futures in 1971, but
| they're hardly the first non-agricultural use.
| dataflow wrote:
| 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?
| jacobr1 wrote:
| They prefer a liquid market
| choeger wrote:
| It creates the market and should thus create the best
| possible price. Think of any speculation as a voting system
| with proof of stake.
|
| Problems always appear when market participants try to
| affect reality to increase their odds, like shorting a
| position and then releasing some ugly news.
| charlieyu1 wrote:
| Provide liquidity. Speculators are trying to make profit,
| but their existence is important to make sure the farmers
| are correctly priced.
|
| Do farmers prefer that? Yes, the larger the futures market,
| the price of selling futures will be closer to optimal. If
| the market is illiquid, farmers often have to sell futures
| at a lower prices to market makers.
| OJFord wrote:
| In general/basics/origins, farmers only want to sell
| futures, because they actually have (intend to have) the
| commodity for physical delivery, and do want to physically
| deliver it.
|
| So who is on the buy-side? Exclusively
| supermarkets/distributors, while exclusively farmers sell?
| I suppose that could work, but I assume it would quickly
| regress into tight relationships like we have (probably
| regionally variable) for smaller market's, like most
| vegetables (vs grain) where as I understand it it's largely
| a direct relationship with the buyer - you probably still
| sell a future contract, but it's not via a central market
| and it is 'farm x will deliver to buyer y', i.e. a pre-
| order if you will, not really a commodity.
|
| And as others say, price discovery, liquidity. What harm
| does completely open (no obligation) do? And maybe you eat
| a lot of potatoes and want to lock in the price today. (Or
| more seriously maybe you're a big baker, but not big enough
| to be buying direct from farm, your miller is. So grain
| price affects you, but ypu can't directly control/choose
| when to take it. Secondary grain futures allow you to hedge
| risk of it moving against you. In turn this means lower
| prices or lower risk of shock price increase to your
| consumers.)
| HWR_14 wrote:
| Theoretically, the societal benefit of lettings randos buy
| and sell contracts is that there is (a) better price
| discovery and (b) better liquidity. There are probably
| theoretical counterarguments to both of those points, but
| it's hard to see alternative systems that provide either or
| both those features.
|
| At a basic level, obviously thee needs to be someone
| assuming the price risk from the farmers, and those people
| will obviously need to be compensated.
| dataflow wrote:
| I buy that there's some benefit, but I don't buy that
| it's significant. And I don't see any reason why I should
| believe this provides a net benefit to society. Sure it
| saves the original parties some money, but then a bunch
| of unrelated parties come in and siphoning money from the
| existing parties. Why should I believe this is net-
| benefiting society?
| HWR_14 wrote:
| If it "saves the original parties some money" than how is
| it "unrelated parties... siphoning money from the
| existing parties"?
| lbotos wrote:
| Your viewpoint here is kinda weird?
|
| The more something trades, the more likely we will have
| _the right price_. When things don 't trade as much, we
| don't actually know what that thing is worth.
|
| This concept is a benefit to society as many things are
| interconnected and correlated, so the more accurate we
| can quickly find the current price (and expected future
| price) the more we can evaluate _value_.
|
| (Also, they aren't "siphoning money" really it's "value"
| because the contract isn't actually _money_ )
| dataflow wrote:
| Just because you've improved the accuracy of a price for
| something, that doesn't mean whatever you're doing to
| achieve this is a net benefit to society, right? Surely
| the idea that this logic doesn't follow isn't weird?
|
| Is the idea that society gets a net benefit from price
| distortions like minimum wage, subsidies, taxes, etc.
| also "weird"? These also make it hard to discover the
| "right price" for goods, therefore it's... weird to have
| them?
| skybrian wrote:
| It's doubtful that farmers care about you in particular.
| However, in general, the societal benefit should be like a
| loan, like insurance, or both, depending on what it is.
|
| Loans are useful and necessary because businesses need to
| buy things before they get paid. It can't all be done using
| Kickstarter! Farming works this way.
|
| Insurance is useful because you get paid when something bad
| happens to you. On a day when you're glad that you had
| insurance, it means someone else lost a bet.
|
| Buying insurance you don't actually need is kind of dumb
| because you'll lose on average, but people do sometimes win
| in casinos, too. Selling insurance when you can't afford to
| lose is risking disaster, but sometimes people get away
| with that too.
| dataflow wrote:
| I don't follow. If the goal is insurance then why not
| just have... something more like insurance? Like when you
| buy insurance for your car or home? We don't let randos
| buy options on the average Joe's mortgage or car loan and
| claim it helps price discovery or liquidity, right? Or is
| it the case that even I can do that and I'm just out of
| the loop?
| gmd63 wrote:
| There is a societal benefit that comes with individuals
| internalizing their own costs of risk. Treating society like
| it's in an economic womb while Mother Finance shields it from
| the world of worries rewards ignorance and in my opinion
| accelerates us toward the world depicted in Idiocracy.
|
| It is nice as a purchaser of such securities that you can
| build things more quickly than usual and transfer worry to
| someone who is willing to be worried for you. However I don't
| believe the SEC financial highway patrol has enough cruisers
| or sophistication to pull over enough abusers to deter the
| disproportionate fraud that increasingly arcane financial
| instruments create.
|
| The costs of a few bad actors building piles of money
| illegitimately do not show themselves immediately. They pop
| up slowly, in dark money investments in destabilizing
| elections, funding of war criminals, market manipulation,
| etc. The societal cost of a charlatan having several
| lifetimes worth of an honest person's influence are grave and
| not to be laughed off.
| mo_42 wrote:
| > 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?
|
| If shares of companies are valued at fair prices it means that
| the finance departments for that companies can raise more
| capital. So companies that bring value to society should be
| able to expand their business.
|
| At the same time, regular people can invest in such companies
| at somewhat fair prices without doing much analysis. Basically,
| because the profits above the market average have been taken by
| smarter investors already. But it's still good to always be
| able to put money somewhere and receive avg. market returns.
| HWR_14 wrote:
| > If shares of companies are valued at fair prices it means
| that the finance departments for that companies can raise
| more capital.
|
| This only true of companies that were underpriced. Overpriced
| companies, either because of hype (Pets.com), fraud (Enron)
| or other reasons (maybe Jim Cramer issued a buy) do not
| benefit from a fairer price.
| mo_42 wrote:
| I guess this could go in both directions. There are also
| underpriced companies.
|
| I know that some people knew that something was wrong with
| Wirecard and they short sold the stock.
| H8crilA wrote:
| Yeah, exactly. There is absolutely no way you could have ETFs
| if the "quick games" were forbidden. Not only because it's
| the HFTs that essentially run the fund on a day to day basis
| (see Authorized Participant for details).
|
| One famous example with a completely extinguished price
| discovery is the Soviet Union. I think this is what killed it
| more than any internal or international political problems.
| [deleted]
| alphanullmeric wrote:
| Sounds like you worry too much about what other people do with
| their own time and money.
| scubbo wrote:
| When it results in a concentration of wealth in the hands of
| people who can abuse it for political ends, or results in
| market crashes that cause knock-on impact to real humans -
| then yes, worrying about it is reasonable and justified.
| alphanullmeric wrote:
| Feel free to not trade in this market then. "Mom they won't
| share" is also not a particularly convincing way to justify
| the right to other people's money.
| jdaw1 wrote:
| I'm the author. Thank you for saying it is an excellent read --
| that was no small amount of work.
|
| You ask "Where is the productive output of all these arbitrage
| shell games?", which is a very fair question. The purpose of
| financial markets, sometimes but not always wholly achieved, is
| to transfer risks to those best able to hold them. E.g., you
| are not the optimal person to hold the risk that, through no
| fault of your own, your house burns down. That risk exists, and
| you are not the optimal holder of it. Hence insurance. A
| Lincolnshire farmer -- and yes, I like the non-abstract solidly
| of the example -- is not the optimal holder of the 'risk' that
| the Australian and Kansas wheat harvests are super-bountiful.
| Markets allow that risk to be transferred to a non-farmer
| better able to hold the risk.
|
| Of course, with markets come some 'unproductive' stuff.
| Likewise, democracy is good, but that is not necessarily
| praising the optimality of all parts of campaign finance
| legislation.
|
| Let me also mention that I am the author of the definitive
| reference book on old Vintage Port: Port Vintages (and
| seemingly the board disallows a link).
| nostrademons wrote:
| Note also that in some cases you _might_ be the optimal
| person to hold the risk that your house burns down, if, for
| example, your liquid net worth is 100x the replacement cost
| of your home. And that 's illustrative of the value of
| markets: you can _choose_ to transact in them, depending on
| your personal circumstances. The insurance market exists
| because for the vast majority of people, rebuilding their
| home is not feasible with their current net worth. But for a
| small number of people it might be, and for a small number of
| firms it 's probably worth it to insure many thousands of
| people, and then you can even slice up the shares of those
| insurance firms and sell them on the stock market so that the
| risk of your house burning down gets socialized across all
| the other shareholders but at the same time you have a stake
| in the profits.
| Folcon wrote:
| Do you mean this[0] when you wanted to link to `the
| definitive reference book on old Vintage Port: Port
| Vintages`?
|
| Also, welcome!
|
| - [0]: https://www.portvintages.com/
| User23 wrote:
| It is an interesting reframe to think of insurance as a,
| roughly, ATM put.
|
| Having some experience with both trading derivatives and
| gambling though, I'm fairly confident saying that it's a
| distinction without a difference. In both cases a little guy
| with an understanding of risk and bankroll management and
| some aptitude for the game, which for trading is a Keynesian
| beauty pageant, can scrape up a few bucks. But most people
| are going to be fish for the house. The derivative markets
| are providing exactly the same service as casinos, albeit
| with considerably higher limits and opportunities for
| crafting complex bets.
| bombcar wrote:
| The derivatives market is like if they let you buy
| insurance on anyone without ah insurable risk.
|
| So I could decide that I think _your_ house is likely to
| burn down, so I buy insurance on it.
|
| That's what enables the gambling. If the only people who
| could buy puts or calls were people who had insurable risks
| in the underlying; it would be a lot smaller market and
| less gambling.
| nostrademons wrote:
| Prices and financial markets in general exist solely for
| information transmission. The central problem of economics is
| "How do you produce the things that your population needs, in
| the quantity and at the time they need them, as efficiently as
| possible?" This is why every centrally-planned economy
| eventually fails, and why we were stuck in the feudal middle
| ages for a millennia. Information (and _incentives_ ) about
| what to produce and how to produce it efficiently weren't
| getting to the population at large, which caught us in a local
| subsistence minima. Financial markets give all the players an
| incentive (in the form of profit) to transmit information (in
| the form of prices) from people who want goods to people who
| can supply them.
|
| This is also behind the theory of why certain forms of
| financial transactions are legal and others are illegal.
| Arbitrage = legal, because it converges prices in two separate
| markets in a way that gives producers in both those markets
| better information about true demand. Futures markets = legal,
| because they smooth out temporal fluctuations in demand so that
| producers only have to worry about producing, while also
| incentivizing the construction of just enough storage &
| buffering to hold that product. Pump & dump schemes = illegal,
| because they distort price information in the market in an
| unsustainable way and then leave later participants to bear the
| cost of this. Same with Ponzi schemes. Equities markets =
| legal, because they transmit information about the overall cost
| of capital within the economy to firms, which can then use it
| to decide the profitability or unprofitability of various
| investments.
| nazka wrote:
| Without them we wouldn't have McNuggets.
|
| McDonald's is known to have almost invented and streamlined
| cooking to industrial level. But McNuggets were made possible
| only through financial engineering:
|
| https://tackletrading.com/tackle-today-the-rise-of-chicken-m...
|
| I just finished some McNuggets so it's even more funny to me
| right now.
| Sherl wrote:
| I am always amazed by Finance. But the engineer in me somehow
| always failed to grapple after few trenches deep into the realm
| of terminologies. I am strongly considering the MITx Finance
| specialization, but this resource is a great stop gap.
| zjmil wrote:
| If you want something related in video form, the lectures[0] from
| MIT 15.401 Finance Theory I [1] by professor Andrew Lo are great.
|
| [0]
| https://www.youtube.com/playlist?list=PLUl4u3cNGP63B2lDhyKOs...
|
| [1] https://ocw.mit.edu/courses/15-401-finance-theory-i-
| fall-200...
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