Question

1. Journalists and Politicians like to point to the trillions of dollars’ worth of notional value of derivative transactions into which large institutions enter with claims that JPM’s derivative exposure is a multiple of our GDP. Why are such statements gross exaggerations? (10 points)

Answer 1

Such statements are gross exaggerations because the notional value of derivative transactions is just that - a notional value. It does not represent the actual liability created for the parties to the transactions. Derivatives are highly leveraged instruments, and the actual liability created is just a fraction of the notional value, and not the notional value itself. For example, interest rate swaps may have $100 million in notional value per contract. However, after netting, the actual liability or payment to either party may be only around 1%, or $1 million.

Therefore, such statements are gross exaggerations.