LONDON – “Shorting” is a tactic well known among the financial cognoscenti. It means betting against an asset with borrowed money in the expectation of making a profit when its value goes down.
A speculator can “short” a government by borrowing its debt at its current price, in the hope of selling it later at a lower price and pocketing the difference. For example: on January 1, 2010, I think to myself that the game will soon be up for the Greeks. I borrow, at face value, €10 million of the Greek government’s 2016 bond, which is then trading at €0.91, from Goldman Sachs for six months. For this, I have to pay Goldman Sachs the yield that it would receive from the bond – around 5% annually at that price, so about 2.5%, or €250,000 – during the six-month term.
I immediately sell that bond in the market, for €0.91, so I get € 9.1 million (€0.91 x €10 million at face value). Fortunately, my bearish view comes to fruition in May, when the full extent of the country’s fiscal problems becomes clear. By June 30, when I am due to return the €10 million in face-value Greek 2016 bonds to Goldman Sachs, the bond is trading at only around €0.72. So I go into the market, buy €10 million at face value for at €0.72, or €7.2 million, and return the bond certificates to Goldman Sachs as per our agreement.
My profit for correctly taking this bearish view is therefore €1.65m – the €9.1m I got by selling the bonds when I borrowed them on January 1, minus the €7.2m that I had to pay to repurchase them on June 30, minus the €250,000 in interest that I had to pay Goldman Sachs for the six-month loan. Voilà – a successful “short” trade.