A time for election futures

FINANCIAL innovations have been blamed for most of the ills that have afflicted the world’s financial systems. Futures, derivates and financial engineering are all smart ideas put into practice. However, every now and then, these ideas are found at the epicentre of financial earthquakes.

In the late 1990s, derivatives were responsible for the collapse of many a hedge fund. The Russian moratorium saw United States-based Long Term Capital Management, which had been trading a lot of spread contracts on Russian debt creating a US$1 trillion hole in the international financial markets. The vanguard of British banking, Barings Inc is no more.

The bank went under as a result of rogue futures trader Nick Leeson’s losses in Nikkei futures. The latest headline is that of one Jerome Kerviel of Societé Generale who lost his bank US$7 billion betting that the European equities markets would continue rallying.

After the derivatives came a new term called financial engineering. In simple terms financial engineering is the creation of new and improved financial products — cash flows — through innovative design or repackaging of existing financial instruments. Collaterised Debt Obligations (CDOs) which are at the heart of the current sub-prime crisis are products of financial engineering.

The bad overshadows the good. All the discussions on financial engineering and derivatives focuses on the losses or negatives but rarely are the profits mentioned. Sub-primes were largely responsible for the bulk of the profits posted by most international banks prior to the current crisis. That is why all of them are exposed in one way or another.

Zimbabwean and many African markets have largely been unaffected by the troubles of the derivatives and sub-primes. Not because we are better at pricing the risks associated with these products or cleverer than our first world counterparts. The reason is that we have not been participating in the markets where these products are traded. The closest Zimbabwe came to having a derivatives market was when Zimace was set up and when banks had equities’ derivative desks. This was in the good old days prior to the 2004 financial turmoil.

Today, it is exactly sixty days into the New Year and 30 days from knowing who the next great leader will be.

March 31 will also mark the end of the first quarter of 2008. As of Wednesday this week the industrial index was only up 156%, compared to the American dollar which has returned 247%. This is despite the fact that the US dollar itself is weakening against other major currencies. Generalising the returns of the stock market using the industrial index, masks the fact that counters like Starafrica, SeedCo, CFI, and Medtech are up 588%; 525%; 471% and 400%, respectively.

Those investors, who were unfortunate to buy shares in Caps, have to a large extent been impoverished. The counter is trading at below its December 31 2007 level. Also in much the same boat are the shareholders of Cottco, Powerspeed, ZPI and RTG. Although still in the positive the distance from zero is negligible. If these guys are to meet their targets for the first quarter then they might have to take on some higher risk. As is well known; risk and return are positively correlated.

Investors in these counters could consider making up for lost time by turning to the esoteric world of financial derivatives. Given that there are no single stock or index futures trading on the Zimbabwe Stock Exchange and the commodity futures are not operational because the country’ s marketing regulations do not facilitate such a market, election futures are, in theory, the only avenue left.

Presidential elections futures have two forms; “winner-take-all” and “vote share”. The forthcoming Zimbabwean presidential election has four candidates Robert Mugabe, Simba Makoni, Morgan Tsvangirai and Langton Towungana. There are a number of permutations that one can structure of the “winner-take-all” variety.

Contracts can be in a winner-take-all form, in which an investor bets on the overall winner. The other variety would be to pick any two out of the above four. In other words, one can bet on Simba beating Morgan, or vice versa. In the “vote share” future, the buyer would purchase a contract stipulating that one candidate will command a certain proportion of the vote. For instance, candidate X will win 33% of the vote.

Both types of contracts would have a fixed purchasing fee and a predetermined payoff. The contracts expire on the day of the elections. The payoff could be anything, from a fixed amount of Zimbabwe dollars, a portfolio of better performing ZSE shares, a tonne of maize/soya beans, a generator or a drum of fuel. This route — unfortunately — is only available in theory as Zimbabwe does not have a futures market. However, there is no law prohibiting an individual setting up an over the counter trade in such futures. In the United States, investors are busy right now betting on a candidate of their choice for the primaries. The Democratic Party race is the one that has elicited much interest.

For those with an appetite for futures, a missed opportunity was the Meikles extraordinary general meeting last December. The resolution on the acquisition of Kingdom was a good candidate for an election future contract. A writer could have structured a “winner-take-all” or a “vote share” contract on this controversial resolution. Some money could have been made or lost.– By Admire Mavolwane