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Entry: Faith-Based Economy Link: http://www.takimag.com/blogs/article/faith_based_economy#20729 Post contents: @ Prozium and John Medaille: When you're talking about $516 trillion or whatever the numbers are, keep in mind that those figures are notional principal. They are NOT the amount of exposure of the financial institutions involved. Say bank A enters into a 5-year, $100 million notional swap with bank B to receive fixed and pay floating. It may not cost anything to get into that swap, and the bank's exposure is most certainly not $100M. Bank A would therefore receive $3M annually (say fixed interest rate is 3%) and pay $3.25M annually (say floating rate is 3.25%), for a net payment of $250,000. If the floating drops to 2.75% in year 2 bank A would receive net $250,000. As you can see, notional principal is very different from total exposure. As I said above, sometimes banks have to post collateral with each other when they enter into these kinds of agreements, and sometimes not--it depends on the reputation and the eagerness of a party to do business with the other party. Bottom line: while the notional value of derivatives are staggering, the actual exposure is far lower; more like orders of magnitude lower. I'm not saying that the financial situation isn't bad; I'm just saying it's easy to misinterpret those numbers if you don't really understand what they mean. Sent at: 2008 07 06