How do investments work?

HappyUser

Hello!



When you want to place a derivative trade (let's say swap), you go to the bank to do it.


Then the bank gives you e.g. one interest rate and you give the bank another interest rate.


Or when you trade with a trader, the trader sells or buys from you at specific prices.


My question is, in these situation, where there are two counterparties, isn't there the case that one of the two counterparties will end up as the loser and the other as the winner from the trade?


And why do people deal with traders and banks, which are experts? They don't know that a trade won't take place if the bank/trader believes that the bank won't be the winner?

short_butt_sweet

in some circumstances, neither counterparty has to be the loser. the parties may have different aims/interests/timespans, so it may make sense for both of them to do the trade.

e.g. i may have savings to invest for my retirement, so i want to buy some equities (suitable for a long-term investment). and somebody else may be at (or near) retirement, so wants to scale down their long-term investments. then it may sense (for both of us) for them to sell me some of their equities.

(in practice, i and the retiree may both be dealing with intermediaries, not directly with one another. and the intermediaries will be skimming something off. that's effectively a cost of executing the buy/sell, which is worth paying when there's a strategic rationale for the buy/sell.)

you do have a valid point that, in the absence of any difference in aims between the counterparties, they can't both win. and especially that, when only one of them is a professional/expert, we can make a good guess at who will be losing.

e.g. consider LOBO loans: a rather complicated form of loans, which banks have been selling to many local authorities in the UK. i think it's pretty obvious that, if it's difficult to understand who is winning and who is losing from the use of these unnecessarily complicated products, we can say with a very high degree of confidence that's it's the local authorities who are losing.

bowlhead99

HappyUser wrote: »

My question is, in these situation, where there are two counterparties, isn't there the case that one of the two counterparties will end up as the loser and the other as the winner from the trade?

As mentioned above this is a gross simplification. For example the person you are buying from might have just bought the instrument from someone else at a lower price but does not want the risk of holding it to maturity and is looking to clear his books by selling it on at a small profit. You however want the instrument to hedge some other asset or liability that you own. Who 'loses' if you, a willing buyer, buy it off the willing seller?

Presumably you are only going to buy if you think it is a fair price for the potential benefits it gives you. If you don't really know what the going rate is, or what it's worth to you, you can look at the market and see how much is being bid and offered to buy and sell and at what price, to ensure you are not paying above the odds. People shop around between investment opportunities just like I shopped around between options for some consumer goods I fancied or the house I live in or my fishmonger haggled at Billingsgate before stocking up.

And why do people deal with traders and banks, which are experts? They don't know that a trade won't take place if the bank/trader believes that the bank won't be the winner?

Are you going to buy your interest rate swap from a guy living under a bridge or from the bartender at your local pub? No, you will probably deal with a representative of a financial services organisation who understands the market because he transacts multiple times per day.

If you don't understand how the market works you should probably not be a direct counterparty to the trade engaging in a battle of wits with all the professionals. Perhaps you could outsource the job to someone who does know what they are doing, which is what institutional investors will do. If you are looking to DIY your financial derivatives trading, you'll find that most of the "bloke down the pub" types don't have much interest in trading interest rate swaps so the market for them in your local pub will be illiquid and you will likely get a better price from the bank or trading desk even though they have more information than you.


Afterthought:
Is your post some kind of lead-up to some spam where you go on to tell us that we can't trust banks and will get beaten by professional traders so we should open up an account with some unregulated online trading site where we can make a tidy profit by creaming some winnings off inexperienced 'bloke down pub' types and hopefully get out quick before the real professionals show up and clean you out?

Or are you genuinely nonplussed about how and why markets exist and function?

Dox

bowlhead99 wrote: »

Afterthought:
Is your post some kind of lead-up to some spam where you go on to tell us that we can't trust banks and will get beaten by professional traders so we should open up an account with some unregulated online trading site where we can make a tidy profit by creaming some winnings off inexperienced 'bloke down pub' types and hopefully get out quick before the real professionals show up and clean you out?

Or are you genuinely nonplussed about how and why markets exist and function?

Look at the random nature of OP's other posts and you'll have your answer...

bowlhead99

Dox wrote: »

Look at the random nature of OP's other posts and you'll have your answer...

Hah, a classic case of losing out from not doing one's due diligence.

I simply clocked that they had been on the forum for a year or so with 100+ posts and might just be a kid or student who was trying to get their head around economics - we all start somewhere. Whereas actually they've started 50+ threads over the last year and generally don't revisit them. My lack of research cost me a wasted commute home - I could have been staring inanely out of the train window avoiding eye contact with other travellers, instead of typing on a phone. :cool:

ChesterDog

A Bowlhead post is seldom wasted.

HappyUser

Lol good luck with doing 'due diligence' to every one who posts here and wasting your time reading their past threads. I guess being stupid to judge 'random nature' (as if we should post in a way to satisfy idiotic norms) of posting comes at a cost.


And it seems that even bankers believe that they rip off people:

https://www.theguardian.com/commentisfree/2012/mar/23/voices-of-finance-structuring-equity-derivatives

I gather that if you deal with the markets it would be fine, but dealing with products/trades from banks, we should be cautious.

Thrugelmir

HappyUser wrote: »

And it seems that even bankers believe that they rip off people:

A newspaper article from 2012. Hardly current news :think:

Brynsam

HappyUser wrote: »

Lol good luck with doing 'due diligence' to every one who posts here and wasting your time reading their past threads. I guess being stupid to judge 'random nature' (as if we should post in a way to satisfy idiotic norms) of posting comes at a cost.

Maybe learn to use Google effectively?