Daily Speculations

The Web Site of Victor Niederhoffer & Laurel Kenner

Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter;  a forum for us to use our meager abilities to make the world of specinvestments a better place.

 

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Steve Wisdom

10/21/04
Derivatives for Grandma

A call today from a retail broker. The offering: paper that pays 11% for one year, then max((30yr-10yr yield spread)*20,0) for 12 years thereafter, callable every six months. [Wall St firm] created the paper to offload 'the other side of a big institutional trade' onto a retail client-base. So far have sold $40m of the paper, I'm told, with demand far greater than expected.

Astonishing to me that this sort of paper is being distributed by the dialing-for-dollars retail broker base.

You'd need to be as clever as George or Justin to value this paper. Certainly Grandma has no idea, beyond trusting her broker.

Great sales angles, high introductory yield, and 'bright line' at zero since you get $0 yield, but not below, if the yield curve is flat or inverted. 'Retail' loves 'can't lose' bets like this, as the blossoming of 'guaranteed' hedgefund wraparounds proves. Values opportunity cost losses, eg time value of money, much less than literal losses. And the hidden optionality of the call feature, hard for retail to understand or value.

So much 'behavioral' food for thought.

Stephen Wisdom, a Pennsylvania-born Harvard graduate, has been Victor Niederhoffer's right-hand man off and on for more than 15 years. He also has been associated with Trout Trading, Societe Generale and Deephaven Fund