Ok, so I've read your posts on the nuts and bolts of the accounting reasoning and quadruple accounting elsewere, but the treatment of derivatives under this framework still confuses me a bit. Take the TRS (total return swap) example here for instance: I get the economic exposure treatment "swap can be understood as matched parallel loans", and I get why you combined the loans into a single swap contract on Archegos' asset side. What I don't understand is since balance sheets should balance, what liability entry on Archegos' liability side corresponds to the TRS recorded as an asset?
That's a good observation. It is a bit of shorthand I suppose. The swap, like other swaps and insurance contracts, actually should have a zero expected value and only properly becomes an asset or a liability when a cash flow one way or the other comes due. So to hedge the liquidity risk for a derivative that could suddenly become a liability, they would need to have had an offsetting conditional exposure, something that would generate cash when they needed it. Which obviously they did not have.
Typically there is a conceptual argument for which side to put a swap on. In this case, Archegos was betting on appreciation, as though they were long the underlying equities, so I put it on the asset side by analogy. But, as you are observing, the derivative can go either way. Archegos learned this lesson the hard way.
"Soon parted" is fascinating. A high-level didactic tool.
Each entry is the key to an understanding of an apparently complex world that, thanks to the explanations and its illustration through the stylized T-accounts, becomes understandable.
Ok, so I've read your posts on the nuts and bolts of the accounting reasoning and quadruple accounting elsewere, but the treatment of derivatives under this framework still confuses me a bit. Take the TRS (total return swap) example here for instance: I get the economic exposure treatment "swap can be understood as matched parallel loans", and I get why you combined the loans into a single swap contract on Archegos' asset side. What I don't understand is since balance sheets should balance, what liability entry on Archegos' liability side corresponds to the TRS recorded as an asset?
That's a good observation. It is a bit of shorthand I suppose. The swap, like other swaps and insurance contracts, actually should have a zero expected value and only properly becomes an asset or a liability when a cash flow one way or the other comes due. So to hedge the liquidity risk for a derivative that could suddenly become a liability, they would need to have had an offsetting conditional exposure, something that would generate cash when they needed it. Which obviously they did not have.
Typically there is a conceptual argument for which side to put a swap on. In this case, Archegos was betting on appreciation, as though they were long the underlying equities, so I put it on the asset side by analogy. But, as you are observing, the derivative can go either way. Archegos learned this lesson the hard way.
"Soon parted" is fascinating. A high-level didactic tool.
Each entry is the key to an understanding of an apparently complex world that, thanks to the explanations and its illustration through the stylized T-accounts, becomes understandable.
Gracias y felicidades. Iñigo
Escribir *Soon Parted* es un placer - ¡gracias a ti por leerlo!