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Forged Banknote

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# Forged Banknote - PowerPoint PPT Presentation

Forged Banknote. Finance is about solving the unknown r ather than applying ready rules . Given. Actors: Stranger = S Shop-owner = SO Shop-owner next door = SOND Actions: S wants to buy an article @\$4. S offers \$10 banknote.

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### Forged Banknote

Finance is about solving the unknown

rather than applying ready rules

Given

Actors:

• Stranger = S
• Shop-owner =SO
• Shop-owner next door = SOND

Actions:

S wants to buy an article @\$4. S offers \$10 banknote.

SO does not have change and gives the banknote to SOND who provides change.

S goes away with the article and \$6 change.

Then SOND comes and says that the banknote is false.

S compensates SOND with a valid \$10 banknote.

Question

What is SO’s total loss?

How to Solve?

Two approaches:

• Calculate everything step by step.

Lengthy calculations where it is necessary to distinguish valid money from false. There is high prob of mistake.

(2) Use arbitrage method.

The answer will be obvious immediately. SOND has zero impact. SO loss is equal to S gain. S gain is obvious.

Arbitrage = Balance Equation

What SO looses, S gains:

SO losses = S gain (BE)

It is hard to calculate losses. It is easy to calculate gains: \$6 in cash + \$4 in value = \$10.

It is important to notice that SOND net position is zero.

Check up

Let us check easy stuff with long calculations – losses. The daybook for SO:

Profit/Loss = Debit – Credit = \$10 – \$20 = –\$10

Sophisticated Note

Changing cash works like a derivative.

The uncertainty is incorporated in the quality of money. There are just two options in the case of forged money (like default). But there is a range of options in the case of dirty money (“dirty” may be treated both literally and figurative).