Derivatives Explained

I am sure most of you not connected to the share market must be puzzled how the world economy has suddenly gone under tail-spin.
You can be sure that our genius would come with an explanation in layman's terms which all of us would understand.
Prakash Bhartia explains it here.


This finally makes sense!!!!!!!!!!

Subject: Derivative Markets( explanation for us common folk)

Derivative Markets

At last, here's what we've all been waiting for:
an understandable explanation of derivative markets.
Heidi is the proprietor of a bar in Detroit. In order to increase
sales, she decides to allow her loyal customers - most of whom are
unemployed alcoholics - to drink now but pay later. She keeps track
of the drinks consumed on a ledger (thereby granting the customers
loans).

Word gets around about Heidi's drink-now-pay-later marketing strategy
and, as a result, increasing numbers of customers flood into Heidi's
bar, and soon she has the largest sale volume for any bar in Detroit.
By providing her customers' freedom from immediate payment demands,
Heidi gets no resistance when she substantially increases her prices
for wine and beer, the most consumed beverages. Her sales volume
increases massively.

A young and dynamic vice-president at the local bank recognizes these
customer debts as valuable future assets and increases Heidi's
borrowing limit. He sees no reason for undue concern since he has the
debts of the alcoholics as collateral.

At the bank's corporate headquarters, expert traders transform these
customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These
securities are then traded on security markets worldwide.

Naive investors don't really understand the securities being sold to
them as these AAA secured bonds are really the debts of unemployed
alcoholics. Nevertheless, their prices continually climb, and the
securities become the top-selling items for some of the nation's
leading brokerage houses who collect enormous fees on their sales, pay
extravagant bonuses to their sales force, and who in turn purchase
exotic sports cars and multimillion dollar condominiums.

One day, although the bond prices are still climbing, a risk manager
at the bank (subsequently fired due his negativity), decides that the
time has come to demand payment on the debts incurred by the drinkers
at Heidi's bar.

So Heidi demands payment from her alcoholic patrons, but being
unemployed, they cannot pay back their drinking debts.
Therefore, Heidi cannot fulfill her loan obligations and claims
bankruptcy.

DRINKBOND and ALKIBOND drop in price by 90 %. PUKEBOND performs
better, stabilizing in price after dropping by 80 %. The decreased
bond asset value destroys the bank's liquidity and prevents it from
issuing new loans.

The suppliers of Heidi's bar, having granted her generous payment
extensions and having invested in the securities, are faced with
writing off her debt and losing over 80% on her bonds. Her wine
supplier claims bankruptcy, her beer supplier is taken over by a
competitor, who immediately closes the local plant and lays off 50
workers.

Then the bank and brokerage houses are saved by the Government,
following dramatic round-the-clock negotiations by leaders from both
political parties.

Ultimately, the funds required for this bailout are obtained by a tax
levied on the employed, middle-class non-drinkers.

Now that's an explanation of derivatives I can finally understand