Better Joy Through Finance

The holidays are, for some, an unbearably stressful time of year.  The food, the parties, the relatives, and, of course, the gifts, all conspire to make miserable what should be fun and enjoyable.  Here at DRS Advisors we are always looking for ways to apply the power of financial engineering to making life more enjoyable, if ruthlessly practical and efficient, and we believe that the process of holiday gifting is in dire need of some restructuring.  We certainly understand that exchanging gifts with friends and loved ones is a joyful end in itself.  However, we also recognize that, from an economic standpoint, this act is profoundly irrational and fraught with inefficiencies, and that the bulk of holiday anxiety derives directly therefrom.  For the past several weeks we've devoted considerable resources to making the holiday season more efficient, and by borrowing a straightforward process from one of the core structures of modern finance (the swap), we have developed what we believe is highly workable solution: bilateral netting.

Bilateral netting, quite simply, involves consolidating multiple cash flows between two counterparties into a single, unidirectional cash flow.  That is, rather than structure a cumbersome series of one-off cash flows between counterparties, the transactions are "netted" out resulting in a single payment.  For example, Counterparty A owes Counterparty B $10, and Counterparty B owes Counterparty A $8.  Rather than exchange payments, Counterparty A simply forwards Counterparty B $2 and calls it a day.

How can we apply this to the holiday season?  Stripped of it's warmth and merriment, the holiday season can be seen as a vast commercial construct underpinned by millions of bilateral cash flows (gifts) between willing counterparties (givers/receivers).  With the notable exception of those treasures offered by Santa to the children of the world, most gifts are obligatory and only marginally appreciated, and many are, regrettably, unwanted.  This is an unfortunate waste of scarce resources, and only serves to stoke the smoldering fire of holiday resentment.  Rather than endure this personal torment (and perpetrate an economic travesty) year after year , we recommend that holiday gifting be restructured as a swap-like transaction, and unfold in the following manner:

• Valuation:  The counterparties shop as usual, developing ideas, perhaps even operating within a budget, and select an item that they would like to give.  They then value the gift (asset), taking into account shipping, custom gift wrapping, batteries, accessories, and any other costs to determine thenotional value of the underlying.
• Contract:  Once the underlying assets have been valued, the counterparties enter into a gift swap agreement, identifying the assets and disclosing their notional values to each other.
• Execution: The transaction is netted out, resulting in a single cash flow between the counterparties.

Example: Let's assume that you are exchanging gifts with your cousin.  Let's assume further that, in a rare display of yuletide rationality, the two of you have established a spending limit of $40.  You each spend time shopping for what you believe would be a suitable gift for each other, taking note not only of the unit price, but any associated costs.  Your cousin has found an electric shaver for you which, including shipping, she has valued at $37, while you have found a decorative ceramic soup tureen at a local artsy boutique which you have valued at $29.  You and your cousin share your gift ideas with one another, and disclose their respective all-in notional values.  You then enter into a gift swap agreement which, via bilateral netting, results in you forwarding your cousin a single payment of $8.

Done.

And at the end of the day, that's what the holidays are really all about: getting it done.  Bilateral netting, while hardly a panacea, is a significant step toward a more efficient, and, therefore, more joyful time of year.

Season's Greetings!