[3611] in Humor
Enron Explained
daemon@ATHENA.MIT.EDU (Andrew Bennett)
Mon Feb 11 16:21:38 2002
Message-ID: <02a301c1b341$d015f2b0$9b39a8c0@LEXX>
From: "Andrew Bennett" <abennett@MIT.EDU>
To: <humor@mit.edu>
Date: Mon, 11 Feb 2002 16:19:38 -0500
MIME-Version: 1.0
Content-Type: text/plain;
charset="iso-8859-1"
Content-Transfer-Encoding: 7bit
Enron explained
NEW YORK, Jan. 18 (UPI) -- Here's how Enron works. It's really quite
simple.
Ismail is a successful mule trader in Peshawar. Every year Ismail delivers
30 mules to the Kabul Mule Market and gets $40 per mule. This year, however,
the Khyber Pass is full of warlord militias, so Ismail is not sure he can
drive his mules to market without losing a mule here and there. Also, the
demand for mules in Kabul seems to be dropping. Maybe he'll only be able to
sell 20 mules, or, God forbid, 15, and then be forced to feed and water the
rest of them on a money-losing trek back home. In other words, it's a scary
market and Ismail is worried about feeding his family.
What Ismail needs is to limit his risk with an Enron derivatives package.
First he pays $2 per mule for a Khyber Pass Derivative, so that any mule
killed or stolen by warlords will be reimbursed at the rate of $20 per
mule -- half the going market rate, but still better than taking a total
loss.
Next he buys Enron Mule Futures. For $28 per contract, he guarantees
delivery of a mule in three months time. He takes 15 of these, figuring that
a guaranteed $28 mule sale is better than showing up in Kabul and
discovering that the mule buyers have been killed by stray bombs.
Meanwhile, at the Enron Mule Trading Desk in Houston, eagle-eyed yuppies are
studying the worldwide mule markets and starting to have their doubts about
those $28 delivery contracts. Mule use is dropping all over Afghanistan,
even as the mule count is dwindling.
Better resell eight of those 15 contracts to a European commodities broker
for $24 each, then make up that $32 loss somewhere else while cutting the
company's exposure in half.
But how to hedge the risk on the other seven? Aha! A blip on the computer
screen. A temporary mule shortage in southern Iran! With a current mule
price of $42 in Tehran, Enron could offer a Linked Mule Swap Double
Derivative tied to the gap between the price of mules delivered in Kabul on
a given date and the price in Tehran on the same date.
Sure, you would rather have the quick-and-clean Iran sale, instead of the
sale in Kabul that requires trucking the mules to a foreign market. But even
if you add in $4 per mule for transport through militia-held territory
and averaged the markets together, you can still clear eight bucks just on
the gap alone. Enron's average price-per-future-mule is now $32.57 when you
include the $4-per-mule loss on the mule futures dumped in Europe. But based
on the amazing $12 Kabul/Tehran trading gap, they can easily put together a
"delivery in either market" contract that will allow them to ask $36 per
mule on their Mule Online Internet trading system.
The first mule future sells instantly for $36, and the price bobs up to
$36.50. Two mules go for $36.75, and then there's a big jump for the last
three mules to $37.90.
Enron has now off-loaded all its price-based mule futures liability for a
profit of $31.70. But this doesn't mean they're out of the mule market in
Central Asia. It's still two months until Ismail delivers his 30 mules, and
Enron is on the hook for his Khyber Pass derivative insurance policy.
Things are not looking good in that part of the world, either. The chances
of a mule being picked off as a road-passage tax are pretty high, and the
loss of the whole herd would be a $600 liability.
Quickly, the financial boys go to work, and part of that liability is resold
to a consortium of Singapore banks, Australian mutual funds, and Saudi
Arabian arms merchant Adnan Kashoggi, thereby reducing Enron's
percentage to 25 percent, or $150 in potential liability against a $15
premium (remember the $2 per mule paid by Ismail), and Enron also takes a
brokerage fee of $20 from the three other partners, thereby reducing its
real liability to just $120. But that's still too much of a spread, so Enron
continues to hedge.
Fortunately, the company has such a diversified trading floor that Enron
mule-market experts can walk over to the traders in the warlord-militia
derivatives department.
Sure enough, at least four tribes near the Khyber Pass are increasingly
concerned about profit margins. There simply aren't enough people to rob.
Things have gotten so bad, in fact, that the warlords are hedging against
the oncoming winter by taking futures positions in stolen chickens, stolen
humanitarian aid trucks, and Western hostages. There's not a mule market
yet, because the warlords have successfully converted many of the
recalcitrant villagers into pack animals.
But Enron knows how to MAKE markets. Quickly the numbers-crunchers go to
work, and they soon determine that the average number of stolen mules per
100-man militia is 1.4 per year. That represents anywhere from $28 to $56 in
lost mule-thievery income if the Khyber Pass is closed or inhospitable to
traders from Pakistan. Amortizing that amount over 12 months, the warlords
have an exposure of anywhere from $2.33 to $4.67 per month in lost pillage.
Hence Enron announces the new Highway Robbery Derivative, in which each
tribe is guaranteed the value of two stolen mules in each 12-month period in
return for paying a premium of $4 per month.
Enron's hedge is now complete, and it is a beautiful thing to behold. The
chances of Ismail losing a mule to a raiding party are approximately one in
30, or 3.33 percent. Since he's paying $60 for his derivative contract, the
expected loss of 3.33 percent of his herd would result in a payment of only
$20 -- a more than comfortable spread.
Meanwhile, if the mule is stolen by a warlord holding a Highway Robbery
Derivative, then the payment to the other side would only be $28 against
premiums of $48. If Ismail simply passes through the Khyber Pass without
incident and sells all his mules at the standard price, Enron pockets $60
from Ismail and $48 each from four warlords, in addition to the previous
profit of $31.70 from that heady Internet mule-futures trading day and the
$20 in packaging commissions.
If each warlord steals his standard 1.4 mules per year, then Enron still
owes six-tenths of one mule to the warlord, or about $22.20 based on a $37
sale price. Total expected profit, based on 5.6 stolen mules, one of which
is stolen from Ismail: $143.20. Total profit from all Ismail-related mule
transactions: $194.90.
See, it's simple when you know how it works. Ask Arthur Andersen.
