Traders Guns and Money

A. Summary of Chapter 1:

This chapter sets the keynote of the book outlining development of 'derivatives and swap' in early 1970's and 1980's. The book starts with drawing an example from a farmer and baker. A farmer needs to ensure he does not lose revenue as a result of fluctuating wheat prices in future while the baker wants to avoid the risk of rise in prices of flour In future. Trading forward contracts hedges both the parties against future price fluctuations, thus bringing the notion of derivatives in financial markets to a reality.

The author explains the idea behind derivatives, which was not to use them for pure speculation, however it turns out that the speculative traders are key market makers for trading these securities. Since the farmer will produce wheat in the future and the baker will need wheat in the future, the concept of derivatives opens up the ability of leverage and speculation. Since there is no money exchange in forward contracts today, it opens up the potential of infinite leverage. However, banks control the behavior of high risk with unlimited leverage by imposing margin requirements.

The concept of SWAP's is introduced with an example of IBM requiring to raise funds in Deutsche Marks and Swiss Francs to pay its international obligations and World bank was in need of Dollars to comply with its policy of raising funds in currencies with low interest rates. Brokering a deal through Salomen brothers, IBM and World bank were able to enter a swap contract IBM paid world bank's dollar obligations and World bank did the same for IBM for it Deutsche Marks and Swiss francs obligations. Magically, all three entities made money as a part of this SWAP agreement.

Some humor is brought into the mix in chapter 1 with the introduction of comparing institutions dealing in derivatives as developing into warehouses with actuaries and quantitative staff deploying computers to deal with rising volume of swaps and other derivative trading. The equipment was housed in big physical locations, compared by the author to warehouses. New clients were sought out by these derivative traders, the search being compared to 'Serial Killings'. With economic growth and rising home prices leaving people with more disposable income, encouraging them to borrow to invest in new financial instruments that left more money in the hands of money managers to play with derivatives.

B. Summary of Chapter 2:

This chapter deals defines the 'sell side' of derivatives, and identifies the sell side with 'Banks and Dealers'. 'Clients' of these 'Banks and Dealers' are identified as the 'buy side'. Not so bright side of 'Banks and Dealers' is revealed in this chapter. The chapter outlines the focus of research conducted by banks as to provide information to executive it is courting for business rather than making meaningful profits for it's general clientele. In author's words - 'Analysts are not there to provide research to clients: if they do come up with something of value, then the firm's trading desk use it to price and trade. What is distributed to clients is advertising but what clients really want is inside information. They believe that the analyst may know something that no other person knows. In