# [OPE] \$596 trillion !!! ???

From: GERALD LEVY <gerald_a_levy@msn.com>
Date: Fri Oct 17 2008 - 14:02:35 EDT

> \$596 Trillion!How can the derivatives market be worth more than the > world's total financial assets?> By Jacob Leibenluft> Posted Wednesday, Oct. 15, 2008, at 4:18 PM ET> > Traders at the New York Stock Exchange> > > > Iowa Sen. Tom Harkin issued a call on Tuesday for regulation of > the "over the counter" derivatives market, which has an estimated > size of about \$596 trillion. By contrast, the value of the world's > financial assets-including all stock, bonds, and bank deposits-was > pegged at \$167 trillion last year by McKinsey. How can the > derivatives market be larger than the entire world's financial wealth?> > Because the same assets might be involved in several different > derivatives. A derivative is a financial instrument whose value > depends on something else-a share of stock, an interest rate, a > foreign currency, or a barrel of oil, for example. One kind of > derivative might be a contract that allows you to buy oil at a given > price six months from now. But since we don't yet know how the price > of oil will change, the value of that contract can be very hard to > estimate. (In contrast, it's relatively easy to add together the > value of every share being traded on the stock market.)> > As a result, financial experts have to make an educated guess about > the total amount at stake in all these contracts. One method simply > adds up the value of the assets the derivatives are based on. In > other words, if my contract allows me to buy 50 barrels of oil and > the current price is \$100, its "notional value" is said to be \$5,000-> since that's the value of the assets from which my contract derives. > If you make that same calculation for every derivative and add those > numbers together, you get something around \$596 trillion-> the "notional value" of the world's over-the-counter derivatives at > the end of 2007, according to the Bank of International Settlements. > ("Over the counter" derivatives refer to contracts that are > negotiated between two parties rather than through an exchange.) > > But the "notional value" isn't usually a very good representation of > what a contract might really be worth to the parties involved, or how > much risk they are taking. (And it isn't easily compared with other > measures of financial wealth-after all, owning the right to buy > \$5,000 worth of oil isn't the same as actually owning \$5,000 of oil.) > Within that \$596 trillion are derivatives that effectively relate to > the same assets-if you have a contract to buy euros in January and I > have one to buy euros in April, we may end up buying the same > currency, but its notional value will get counted twice. Moreover, in > many instances, the "notional amount" is just a benchmark that never > even changes hands-as in the case of the interest-rate swap, by far > the most common type of derivative. Likewise, because derivatives are > often used to hedge risks, there's a good probability that many > contracts in the system essentially cancel one another out.> > An alternative way to measure the size of the derivatives market is > to calculate the instruments' market value-which refers to how much > they would be worth if the contracts had to be settled today. Gross > market value of all outstanding derivatives was \$14.5 trillion at the > end of 2007, less than one-fortieth of the \$596 trillion estimate. > (That number shrinks to about \$3.3 trillion once you take into > account contracts that directly offset one another.)> > Still, the concept of "notional value" is not entirely irrelevant. > For one, growth in the notional value of all derivatives-which has > gone up about fourfold in the last five years-does give a reasonable > indication of how fast the market is expanding. And for credit > default swaps, a derivative at the center of the current financial > crisis, the growth has been especially large-with the total notional > amount rising from just \$2.69 trillion in 2003 to \$54.6 trillion this > year.> > Got a question about today's news? > > Explainer thanks Karsten von Kleist and Carlos Mallo of the Bank of > International Settlements, Richard Metcalfe of the International > Swaps and Derivatives Association, Kevin Mukri of the Office of the > Comptroller of the Currency, and Rene Stulz of Ohio State University.

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Received on Fri Oct 17 14:15:40 2008

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