Derivative Risks of Financial Stocks

**blast_investor** Mon Mar 28, 2005 11:59 pm

Derivative Risks of Financial Stocks
Comment here

**jeep** Tue Mar 29, 2005 1:32 am

It is true that derivatives makes the accounting book difficult to read. But not all financial institutions have high derivatives. Both Buffett and Lynch have/had large positions in the financial sector. I figure it's important to choose the right ones with transparent book keeping.

BTW, on JPM issue, I didn't read their 10K, so not qualified to comment on it. It is a very promising potential because of the CEO-to-be (yes, I know, we value investors don't bet on that.). Jamie Dimon is the wonder boy in this industry, a true master in cost-cutting, especially with mergers and acquisitions. There was a rumor or joke or whatever, saying that JMP merged with ONE in order to get Jamie Dimon. Had his relationship with Sandy Weill not turned sour, he would have been the CEO-to-be of Citibank.

**afan** Tue Mar 29, 2005 10:46 am

Re: Derivative Risks of Financial Stocks
3x for providing the excellent illustration. And I am a little bit curious about the following sentence:

"The company would pay a special entity or third party certain amount, say 100 million, plus 5 million fee for the derivative service, and then the third party would pay back 100 million to the company in return..."

How did they do this? They need to report where every cent goes, right? and why did they do it through derivatives, not equities?

3x:)

blast_investor wrote: Comment here

**Siliconland** Tue Mar 29, 2005 11:23 am

As far as I understand, a financial entity can sell their derivative to public as long term bond.
For example, say Fannie May has 100 million motage with interest rate 6% on hand. It can wrap this 100 mil into a bond with fixed interest rate 5% and sell to public investors. This way, FM can get instant 100 M return. Public investor can have a 5% investment return, and actual borrower will pay for those interests. Does this make sense?

**blast_investor** Tue Mar 29, 2005 12:20 pm

Nowadays, derivatives are very complicated.

For example, insurance can be used as tool of derivatives. many times, derivatives have no meaning other than manipulation of earnings, which was the case for FNM.

Very tough for investors to know what is going on behind the complicated books.

**blast_investor** Tue Mar 29, 2005 12:21 pm

Re: Derivative Risks of Financial Stocks
Equity accounting rule is very clean and straight forward.

Derivatives rule is not complete and it is tough to account for different
types of derivative.

afan wrote: How did they do this? They need to report where every cent goes, right? and why did they do it through derivatives, not equities?

3x:)

blast_investor wrote: Comment here

**afan** Tue Mar 29, 2005 12:38 pm

3x Siliconland and blast:) I understand it a little bit more :oops:

**howiez** Fri Apr 01, 2005 2:01 pm

i am a newbie and this question may seem naive, if high level officer manipulate derivative, can it be detected on the cash flow statement?

**blast_investor** Fri Apr 01, 2005 4:54 pm

For many non-financial stocks, cashflow many times show up suspiciously out of wack due to derivative cheating.

But again, many financial stock books are very messy, CEOs and insiders can manipulate cash flow as well.

**blast_investor** Fri Apr 01, 2005 8:32 pm

great_deals_z,

You brought up an important value investing rule: Sell on poor cash flow stock, unless there is a good reason for that poor cash flow ( for most cases, there is no good reason other than cheating).

Latest case is UTSI, UT.Startcom, a Chinese stock. I said days before that its business model sucks. Not only that, its cash flow is so small compared to its earning, which indicates accounting trouble. This stock is a good example that why earning does not work, and cash flow and balance sheet is more important than earning in stock market investment. A stock like UTSI is performance bomb for any long term investors.

Cash flow problem is not just due to derivatives, it can be any other accounting irregularities as well.