Derivatives-Instruments of Wealth Transference & Destruction - by Stephen Cheesewright, Executive Director, Walter Turnbull

1. MELBOURNE SYDNEY CANBERRA
Derivatives-Instruments of
Wealth Transference
Currency Hedging in Turbulent Times
November 2003

2. Outline
Introduction
Why the title?
Four parts to the paper
– Case for the Prosecution
– Case for the Defence
– Effective use of Derivatives
– Policy and Procedural Safeguards

3. The Case for the Prosecution
Derivatives – Why do they evoke such an
emotional response?
Derivatives and Tulips
Warren Buffet and the Time Bomb
– Dominoes
– Failure of Diversification
– Lack of Diversity of Views

4. The Case for the Prosecution
Warren’s concerns which affect you
– Hell – easy to get into, hard to get out of
– Mark to model?
– Just what you need – A downgrade
The Fable of the Wizard

5. The Case for the Prosecution
Enron’s Revenues
Year 2000 USDM 1999 USDM 1998 USDM
Non-Derivative revenues 93,557 34,774 27,215
Non-Derivative expenses 94,517 34,761 26,381
Non-Derivative gross margins (960) 13 834
Gains (loss) from derivatives 7,232 5,338 4,045
Other expense (4,319) (4,549) (3,501)
Operating income 1,953 802 1,378

6. The Case for the Prosecution
Enron
- The Opacity of Derivatives
- Creation of Revenue
- ‘Raptor’
- LJM2

7. The Case For The Defence
Enron – An accounting or derivatives ‘abuse’?
The ‘Benefits’ of Hindsight
So you think you can avoid using derivatives??

8. Effective Use of Derivatives
International Trade
- Locking in estimated profit
- Decision making with a foundation
Managing Translation Risks
Accessing offshore capital markets
Separating the borrowing and hedging
decision

9. Policy and Procedural Safeguards
Policy
- Have one
- Approved by the Board
- Make it specific
Using particular financial instruments
- Have a sound rationale
There is no ‘free lunch’ and there are no zero
cost options

10. Policy and Procedural Safeguards
Employ the ‘KISS’ Principal
Think hard before you sell an option
(unless you are a bank)
Back up Systems AND People
Invest in Procedures – They are your
safety net