Swap Derivatives
$500 trillion in notional value, and banks just sit in the middle matching two companies with opposite fears. One basis point on $100 trillion is $1B/year at 95% profit.
Salomon Brothers traders realized something in 1984. A company borrowing money wanted certainty. General Electric feared rising interest rates, but locking in a fixed rate for 20 years meant paying premium upfront. Another company wanted the opposite. They feared falling rates. The traders created a swap. General Electric agreed to pay Salomon a fixed 5% for 20 years. Salomon paid General Electric the market rate. If rates rose to 8%, General Electric won. If rates fell to 2%, Salomon won. Both got what they wanted. Salomon kept the difference as fee income. Swaps became the largest derivatives market on earth.
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