Suppose there is someone with an investment horizon of 10 years (Retired Bob), and another person with an investment horizon of 30 years (Hungry Joe). Retired Bob doesn't want to take risk, but Hungry Joe does. So they figure Retired Bob should loan 50K to Hungry Joe at an interest rate of 2%, which Hungry Joe invests into riskier asset.
However, Retired Bob and Hungry Joe both want to limit counter party risk, so they concoct the following derivative contract instead:

  1. Retired Bob invests the cash into the riskier asset
  2. Every 6 months, if the total market value of that investment goes below 50K, Hungry Joe transfers the shortfall to Retired Bob in cash
  3. Vice versa, every time the market value of the investment goes above 50K, Retired Bob transfers the surplus to Hungry Joe in cash
  4. After 10 years, Hungry Joe owes Retired Bob capital + 2% interest, while Retired Bob owes Hungry Joe the capital gain + dividend, and they clear the difference

The point of this as opposed to just Bob lending cash to Joe is to limit counter party risk. Had Bob just lent the cash to Joe, and the investment was 50% underwater after 10 years, and then Joe dies in an accident, Bob could be left with a large loss. Vice versa, if the investment went up 200% and Bob dies, and for whatever reason Joe can't get to the money, he will miss out on the gain.
By balancing the accounts frequently, the loss can be limited on both sides (while admittedly the loan's value is decreased, because it's like a rolling short-term loan.

Does this make sense? Or am I missing something?


In principle it does make sense.

However creating such a derivative product between 2 individuals for the amounts involved is next to impossible as it would involve quite a few regulations.

One may still be able to work this out as a contract. Enforcement of such contract may have to be in good will... Else getting this to courts as civilian dispute may be expensive.

The taxation can be nightmare more so as this is not a standard contract. If its looked as loan or gift or psudo stock advisory... Each have it's own nuisances. For example regulator may see this as investment advice by RB to HJ who is not a family member and RB is not qualified advisor.

The time period need to be well defined or thresholds defined, else there could be quite a bit of movement in volatile markets

  • Thank you for the answer. I suppose that's why banks exist, but it would be really nice if a more P2P like solution can be found. Maybe another startup idea... – Enno Shioji Oct 4 '18 at 7:26
  • @EnnoShioji Potentially yes. If structured rightly with all regulations taken care; maybe there is a market out there. – Dheer Oct 4 '18 at 8:06

Note: Details in the question have changed. This answer relates to the question as originally posed.


The deal is inequitable.

These points look like the following:

  • RB has a short option to sell at x% and long option to sell at x%, with HJ as the counter-party in both cases. Option duration is 10 years and net option premium is 2% to RB, payable upon option expiry.

  • RB also buys the underlyer in the market but HJ has the right to all its capital gains and dividends after 10 years.

This looks like a raw deal for RB. If the deal holds, he recoups his capital + 2% after 10 years. If the deal falls through, he is exposed to the asset's price fluctuations, unhedged.

On the other hand, HJ gains exposure to the asset, effectively buying it for the starting market price + 2%, payable after 10 years.

If the deal holds, HJ has a cheap loan (2% over 10 years), repayable some time within that 10 years, and has full exposure to the asset, realisable at 10 years. If the deal falls through, HJ does not gain exposure to the asset but also has no commitment whatsoever from the deal - not even the 2% interest.

Based on the wording, if one option is exercised part-way through, HJ gains the asset (and full exposure to its capital movements and dividends), but RB is still on the hook to fulfill #4 at the end of 10 years - effectively giving HJ double exposure to the asset from the time of exercising.

If both options are exercised, RB needs to sell 2 lots of the asset but only bought 1 lot. By needing to buy the second lot in the market, RB is exposed to uncapped losses. Worse, points 2 and 3 don't actually restrict the deal to a single option each way - if the price fluctuates around x%, RB is potentially exposed to many rounds of this.

Further, I've assumed that "that money" in the point 2 and "that amount" in point 3 of the question both refer to the original price of the asset. Otherwise the related 'options' trigger when the difference between the market price and x% is tiny - so HJ gets to buy the asset at that tiny price, pushing the deal even further in HJ's favour.

In the worst case, RB buys the asset at market price and sells it for peanuts to HJ, gains 2% after 10 years and still has to pay HJ all the dividends and capital gains (but absorbs all capital losses), and after the first exercise of the 'options', is exposed to multiple rounds of uncapped losses at each option exercising.

The deal is not in RB's interest, so much so that it might well be called a scam.

  • Edited the content to hopefully make it non scammy. Basically what I'm trying to do is let HJ use leverage and BR provide that leverage as loan (while limiting counter party risk) – Enno Shioji Oct 3 '18 at 6:28
  • 2
    @EnnoShioji Please don't edit your question to change the fundementals, as that doesn't allow answers to stand on their own feet. – Grade 'Eh' Bacon Oct 3 '18 at 17:59

This answer relates to Revision 2 of the question.

This is a raw deal for RB.

At the start, RB buys $50K of assets.

During the 10 year term, RB gives away 100% of upside and is protected 100% on the downside. During this time, HJ gets 100% exposure to the asset without actually paying for it. If the price goes to $200k, RB pays HJ $150k. The next round, the lost HJ pays RB is $50k, assuming the asset value drops to zero. RB can sell the asset, but only once. The asset can cross to high valuations multiple times.

At the end of the 10 years, RB effectively sells the asset for cost + 2%.

So RB is risking unbounded loss in return for a guaranteed 2% return ($1k) over 10 years and up to a theoretical and unlikely $1 million gain. This is not consistent with RB’s desire to avoid risk.

  • Hm good point about the increased risk during high asset price... – Enno Shioji Oct 4 '18 at 21:49

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