I agree that the assumptions seem crazy, my only point was that you would have thought the risks you just rightly pointed out should be easily explainable, even if the products inner workings are complex. From your comments, I was trying to understand how even you were having a hard time with them, and I now see that it’s the risk as much as the complexity. I hope I’ve understood you now, and that my point is clearer.

Don the libertarian Democrat

PS Your blog is great. I’m learning so much from it, but I won’t blame my mistakes on you. Take care

Quit being a complete and utter jerk. The headline was a direct quote from the Times Online, And Yves’ intro was not alarmist, despite your efforts to depict it as such. The FX markets HAVE been hugely volatile, the yen made its biggest move in what, 26 years, the FED and IMF just created huge new facilities to stop the run on emerging markets. Or were you asleep while that was happening?

You dump on Yves yet come here to read. If you don’t like what is here, quit reading rather than making lame, nasty comments. You offer not ONE SHRED of data, this is fact free, useless bitching.

If you just want to pick fights, go to a political blog. I find your comment negative and pointless. No one is holding a gun to your head to make you read this blog. Yves presents information, all you do is complain.

The shortcoming in the list above is ’stable currency”. In a world of floating currencies (or mainly floating, and Japan was not one of the ones maintaining a dollar peg) the FX risk is huge, although for extended period (perhaps up to a couple of years with not too much movement) it can look low.

And if you read the stories on Japanese retail currency traders, they were as frenetic last year as day traders in the tech bubble here.

The yen was in fact cheap, so the risk was that despite the pickup in yield, you would lose far more due to a fall in the higher-yielding currency. When I was a kid, no one would EVER think of making deposits in higher-yielding currencies, everyone understood that the high yield was a big big signal that a price fall was in the cards.

Don the libertarian Democrat

“Japanese regulators were once hugely protective of retail investors and placed tough restrictions on what products could be sold to them …
The products, which are known as power reverse dual currency notes (PRDC), were sold to Japanese households as simple products offering higher yields than regular savings but the bonds were in reality hugely complex structures “with 15 moving parts and multiple points of pain”, derivatives experts at RBS in Tokyo said.

The products combine exposure to foreign exchange, interest rate differentials and domestic inflation …”

Topic: Reform

the above can go a long way toward a definition of the current crises to educate the public on what has happened to them and how.

US News media, if they understand it themselves, are useless -indeed, worse than useless because their skill is acting as if they know what they are talking about and people starved for news who watch c-span think they are being educated by congressional hearings that further exploit this absence with sensationalized history, pandering to the public, and more propaganda from witnesses.

every financial instrument including credit cards, mortgages and bank agreements sold to the public must feature language that can be understood by any high school student with an above B average grade.

The products, which are known as power reverse dual currency notes (PRDC), were sold to Japanese households as simple products offering higher yields than regular savings but the bonds were in reality hugely complex structures “with 15 moving parts and multiple points of pain”, derivatives experts at RBS in Tokyo said.

The products combine exposure to foreign exchange, interest rate differentials and domestic inflation

US Reform

the above can go a long way toward a definition of the current crises to educate the public on what has happened to them and how.

US News media, if they understand it themselves, are useless -indeed, worse than useless because their skill is acting as if they know what they are talking about while people starved for financial news watch c-span and think they are being educated by congressional hearings that further exploit this absence of news with sensationalized history, pandering to the public, and more propaganda from witnesses.

every financial instrument including credit cards, mortgages and bank agreements sold to the public must feature language that can be understood by any high school student with an above B average.

as another example, i was involved in putting together a similar investment structure linked to emerging markets debt. like the prdc’s, these were long dated, with a leveraged coupon, this time linked to the underlying emerging markets risk. also like the prdc’s, thanks to market volatility, most of these have now turned into long-dated zero coupon bonds.

i feel very sorry for the clients that bought this product. i personally thought it was a good structure at the time – something i might have invested in myself. emerging markets debt is still a very good long term investment, but the amount of leverage built into the structure meant that it was simply not able to withstand such extraordinary market volatility.

i suspect prdc’s are a similar story. currency forward curves used for pricing these structures are based on interest rate differentials. forward curves said the yen would appreciate rapidly, but from an economic and geopolitical perspective this did not make sense (and indeed, still does not make sense). so “monetising” that forward curve via the carry trade is a sensible strategy, provided that you can stay in the trade for the long term. the problem is that when you build a lot of leverage into the investment structure, like prdc’s do, it becomes impossible to weather big storms like the one we have just seen, and you end up losing everything.