Title: Traders, Guns & Money
Author: Satayajit Das
Year:2006
Publisher: Prentice-Hall
ISBN: 0 -273-70474-5
Summary
This book deals chiefly with financial derivatives. Derivatives
offer an excellent possibility to cause massive financial damage is misused,
and this book offers a smorgasbord of examples in which this indeed
happened. It reads a little bit like a gossip magazine at times, only in
this case, the main subjects are not celebrities, but derivatives traders -
not nearly as well-known, but often at least as rich as celebrities.
Furthermore, the book is essentially a list of anecdotes with
little structure - probably a good thing, as the theory behind finance isn't
nearly as exciting as the colossal blowups.
Prologue
In the prologue, the author describes how an Indonesian noodle maker is
obliterated by a bad derivatives trade. Both the selfish
greed of the
bankers that set up the trade (and receive a 30% slice in their personal
bank accounts), and the profound stupidity of the noodle makers for agreeing
to a transaction they didn't understand are spelled out.
Financial WMDs - derivatives demagoguery
This chapter starts with different opinions about derivatives - necessary or
evil? and then with an explanation about what derivatives (in particular
options) are, which is rather good. He then goes about to explain the
quaint concept of
basis risk, and explains some
swaps. Of course,
all the ways to
screw this up are described in vivid detail.
Beautiful lies - the sell side
This chapter deals with the sell side, which are the banks making derivative
structures to provide to investors, often pension funds, insurance companies
and other banks. The important role of
alcohol and more
carnal
pleasures in securing the deal are detailed. The investment advise seems
sound: if there are investors near
limousines in an
"interesting" investment opportunity, you are too late. Apart from the
entertainment, the cleverness of the sell side is painted.
In this chapter, the buy side is described. Given that most of us, as
private investors, are part of the buy side, it's an interesting chapter,
especially given that the different flavors in which you can get ripped off
are detailed. The bottom line is that trading and derivatives are an
excellent ways of parting
fools with their
money.
Show me the money - Greed lost and regained
This chapter is essentially a collection of anecdotes about trading in
general, and some spectacular blowups in particular. Good reading, but not
the most interesting part of the book.
The perfect storm - risk management by the numbers
The abject failure of risk management in banks and hedge funds is explained
using the example of Long-Term Captial Management, a famous hedge fund that blew up in 1998. The
basic reasons why risk management is done wrong, and if done right,
misunderstood are explained well. I'd like to add the personal observation
that if a person is canny enough to be a good risk manager, he/she would
also be canny enough to be a good
trader or
quant and make roughly 4 times
more. I
Super models - derivative algorithms
This chapter is about
quants - quantitative analysts. Quantitative
analysts are supposed to be smart people, usually with a
PhD, typically in
physics. They apply exact methods to the not always very exact world of
trading. Furthermore, geeky academicians and jock traders create an...
interesting atmosphere which is caught well in the book, although it must be
said that as trading is getting more professional, the traders are becoming
more geeky themselves. The
Black-Scholes formula, the heart of modern
derivatives trading, is explained, but this is done rather poorly. The
principle of delta hedging is explained rather well.
Games without frontiers - the inverse world of structured products
A
Structured product is a financial construction - a contract, really -
with a non-standard payoff. In practice, this can mean that anything is
possible, up to a bond that pays interest based on the amount of rain days
(useful for hedging the price of frozen concentrated orange juice-duh!). It
starts with a discussion of the blowup of Orange County in Florida by the
stunning mismanagement of its
treasurer. Furthermore, the interesting
antics of the Japanese yen and its zero percent interest are discussed,
especially how people lost money on it. The structures are described in
detail, but again, I find the explanation a bit hard to follow.
Share and share alike - derivative inequity
The wonderful practice of
dividend stripping using options is explained,
along with some other very interesting ways of dodging government rules
using options. This is a pretty solid chapter for a
professional, because
these types of
arbitrage can still be done.
Credit where credit is due - fun with CDS and CDO
This is a very impressive chapter in the sense that it accurately describes
the danger the
credit market is in just
before the whole thing came
crashing down. It makes it quite clear what the huge risks were that banks
and in particular insurers took. These risks lead to the current
credit
crisis and the bailout of
Freddie Mac,
Fannie Mae and
AIG.
Epilogue
The fate of the Indonesian noodle maker is revealed. This story is the only
story that continues through the whole book.
Opinion
For the average hobby investor the book is probably interesting, if at times
a bit technical. You can skip over the parts where the more... creative
derivatives are discussed and still enjoy the book, though. The descriptions
are not particularly illuminating, although Google should be able to fix
that. Especially a beginning professional can pick up some useful ideas and
concepts from this book. While there are no really concrete money - making
ideas in it, a good grasp of the principles can help in avoiding problems -
learning from other people's mistakes is better and certainly cheaper than
learning from your own.