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Read book online ยซNaked Economics by Wheelan, Charles (spanish books to read .txt) ๐Ÿ“•ยป.   Author   -   Wheelan, Charles



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attempts) reported to the International Maritime Organization in 2005. This is why firms sending cargo through dangerous areas buy marine insurance (which also protects against other risks at sea). When the French oil tanker Limberg was rammed by a suicide bomber in a speedboat packed with explosives off the coast of Yemen in 2002, the insurance company ended up writing a check for $70 millionโ€”just like when someone backs into your car in the Safeway parking lot, only a much bigger claim.3

The clothing and shoe company Fila should have bought insurance before the 2009 U.S. Open tennis tournament, but didnโ€™t. Like other such companies, Fila endorses athletes and pays them large bonuses when they do great things. Fila endorses Belgian tennis player Kim Clijsters, winner of the U.S. Open, but opted not to buy โ€œwin insuranceโ€ for the roughly $300,000 in bonus money they had promised her for a victory. (This was an expensive decision, but perhaps also an insulting one for Ms. Clijsters.) The insurance would have been cheap; Clijsters was unseeded, had played only two tournaments since leaving the game to have a baby, and was considered a 40โ€“1 long shot by bookies before the tournament.4

The financial markets provide an array of other products that look complicated but basically function like an insurance policy. A futures contract, for example, locks in a sale price for a commodityโ€”anything from electrical power to soybean mealโ€”at some defined date in the future. On the floor of the Board of Trade, one trader can agree to sell another trader a thousand bushels of corn for $3.27 a bushel in March of 2010. Whatโ€™s the point? The point is that producers and consumers of these commodities have much to fear from future price swings. Corn farmers can benefit from locking in a sale price while their corn is still in the groundโ€”or even before they plant it. Might the farmers get a better price by waiting to sell the crop until harvest? Absolutely. Or they might get a much lower price, leaving them without enough money to pay the bills. They, like the rest of us, are willing to pay a price for certainty.

Meanwhile, big purchasers of commodities can benefit from being on the other side of the trade. Airlines use futures contracts to lock in a predictable price for jet fuel. Fast-food restaurants can enter into futures contracts for ground beef, pork bellies (most of which are made into bacon), and even cheddar cheese. I donโ€™t know any Starbucks executives personally, but I have a pretty good idea what keeps them awake at night: the world price of coffee beans. Americans will pay $3.50 for a grande skim decaf latte, but probably not $6.50, which is why I would be willing to bet the royalties from this book that Starbucks uses the financial markets to protect itself from sudden swings in the price of coffee.

Other products deal with other risks. Consider one of my personal favorites: catastrophe bonds.5 Wall Street dreamed up these gems to help insurance companies hedge their natural disaster risk. Remember, the insurance company writes a check when a tree falls on your house; if a lot of trees fall on a lot of houses, then the company, or even the entire industry, has a problem. Insurance companies can minimize that risk by issuing catastrophe bonds. These bonds pay a significantly higher rate of interest than other corporate bonds because there is a twist: If hurricanes or earthquakes do serious damage to a certain area during a specified period of time, then the investors forfeit some or all of their principal. The United Services Automobile Association did one of the first deals in the late 1990s tied to the hurricane season on the East Coast. If a single hurricane caused $1.5 billion in claims or more, then the catastrophe bond investors lost all of their principal. The insurance company, on the other hand, was able to offset its claims losses by avoiding repayment on its debt. If a hurricane did between $1 billion and $1.5 billion in damage, then investors lost a fraction of their principal. If hurricanes did relatively little damage that year, then the bondholders got their principal back plus nearly 12 percent in interestโ€”a very nice return for a bond.

The same basic idea is now being used to protect against terrorism. The World Football Federation, which governs international soccer, insured the 2006 World Cup against disruption due to terrorism (and other risks) by issuing $260 million in โ€œcancellation bonds.โ€ If the tournament went off without a hitch (as it did), the investors get their capital back along with a handsome profit. If there had been a disruption serious enough to cancel the World Cup, the investors lose some or all of their money, which is used instead to compensate the World Football Federation for the lost revenue. The beauty of these products lies in the way they spread risk. The party selling the bonds avoids ruin by sharing the costs of a natural disaster or a terrorist attack with a broad group of investors, each of whom has a diversified portfolio and will therefore take a relatively small hit even if something truly awful happens.

Indeed, one role of the financial markets is to allow us to spread our eggs around generously. I must recount one of those inane experiences that can happen only in high school. Some expert in adolescent behavior at my high school decided that students would be less likely to become teen parents if they realized how much responsibility it required. The best way to replicate parenthood, the experts reckoned, would be to have each student carry an egg around school. The egg represented a baby and was to be treated as suchโ€”handled delicately, never left out of sight, and so on. But this was high school. Eggs were dropped, crushed, left in gym lockers, hurled against the wall by bullies, exposed to secondhand smoke in the bathrooms, etc. The experience taught me

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