Unusual Financial Instruments

Unusual Financial Instruments

Most people have heard and are familiar with bonds, equities and derivatives.  However, what are some of the more unusual financial instruments?  In this article, we take a look to find out.

Bespoke Tranche Opportunities

Post the 2008 financial crisis, Collateralised Debt Obligations (CDOs) have started to make somewhat of a comeback.  Losing their tainted ‘CDO’ name, they are now called ‘Bespoke Tranche Opportunities’ (BTOs).  BTOs are much more tailored than traditional CDOs and highly customised based on investor’s requirements.  They are essentially a CDO that is backed by single-name Credit Default Swaps whose primary investors are hedge funds.  BTOs are highly illiquid with a very small secondary market.  This makes them very risky as a lack of a market makes daily pricing difficult.

At present, BTOs are not thought to be a threat – $50 billion (USD) were sold in 2017, substantially lower than the peaks achieved by CDOs seen in the previous decade.

Weather Derivatives

With the first deal undertaken in July 1996, Weather Derivatives are part of the group of futures contracts that trade on goods that have no intrinsic value.  The point is that although the weather in itself has no intrinsic value, it can adversely affect (via a storm, for example) goods and services that do have an intrinsic value.  For example, a shipping company would typically have insurance if they have suffered a loss due to adverse weather conditions.  The issue with indemnity insurance is that in order to receive compensation, a company has to demonstrate that it has suffered a loss.  With a weather derivative, no proof of loss is required.  If the weather is bad, you receive protection.

Catastrophe Bonds

These bonds behave in a similar way to Weather Derivatives in that they offer financial protection in the event of an awful event.  Issued by insurance companies, these bonds help insurers to ensure they can actually pay out their policies in the event of a disaster situation.  They behave in a similar way to any other standard bond.  Insurance companies will pay a coupon to the investor during good times.  In the event of a catastrophe, the insurance company no longer has to pay the coupon, and the investor loses their entire principal.  As can be seen from this example, Catastrophe Bonds are extremely risky.

Bowie Bonds

Named after David Bowie as he was the first artist to have this type of security issued after him, these types of securities are essentially a bond that is backed by the royalties from an artist’s catalogue.  These bonds are not unique to Bowie.  In the summer of 2012, Goldman Sachs announced it was issuing a bond backed by the royalties of Bob Dylan’s catalogue.

Peer-to-Peer (P2P)

P2P’s are a lending service, such as the Lending Club or Prosper, whereby an investor can invest small amounts of money in tiny tranches of other people’s loans.  Yields on the loans can vary considerably, but can go as high as 27 percent.  Borrowers would potentially use this ‘crowd-funding debt’ as it can be cheaper for them than, for example, their overdue credit card debt. 

Movie Futures

Movie Futures or Box Office Futures are a type of futures contract whereby investors trade shares in upcoming movies based on their predicted performance.  The idea for Movie Futures first started in the United States in 1996 with the launch of the game Hollywood Stock Exchange (HSX).  HSX was a multiplayer game that allowed players to buy and sell shares of upcoming films, actors and directors.  In 2001, HSX was bought by Cantor Fitzgerald, who planned to create a real-world trading exchange based on the concept.  The project was sadly put on hold due to the effect the events of 9/11 had on Cantor Fitzgerald.

The idea resurfaced in 2007 when Media Derivatives Inc. (MDEX) was formed with the aim of creating an electronic futures exchange with contracts that were based on the results at the box office.  One advantage of MDEX was that if a large film studio felt a particular movie would be a flop at the box office, they could short the movie on the exchange in order to recoup some of the losses they made from the movie.

Before any contracts were actually issued, the Motion Picture Association succeeded in persuading the regulatory authorities to ban the practice.  The concern was the ease at which the market could be manipulated by the film studios.  By changing the date that the film premiered or restricting the number of theatres the film was shown in, the film companies could manipulate the box office success for their own gain.

In July 2010, the U.S. Senate passed financial regulation legislation, which amongst other items, banned the practice.

James Girling
Managing Consultant

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