Vassal Coupon Contracts

A Vassal Coupon Contract (VCC), or "coupon", is a contract which gives the buyer (the owner or holder of the coupon) the right, but not the obligation, to buy or sell the lordship of a number of human vassals (here on refered to as the Human Resource) at a specified strike price on a specified date, depending on the form of the coupon. The strike price is set by reference to the GDP per capita (GDP divided by the population of serfs) of the human resource’s territory of origin on the day a coupon is taken out. The seller has the corresponding obligation to fulfill the transaction – to sell or buy the human resource – if the buyer (owner) "exercises" the coupon. A coupon that conveys to the owner the right to buy at a specific price is referred to as a coupon call; a coupon that conveys the right of the owner to sell at a specific price is referred to as a coupon put.

The seller may grant a coupon to a buyer as part of another transaction, such as a share issue or as part of a dowry, otherwise a buyer would pay a premium to the seller for the coupon. A coupon call would normally be exercised only when the strike price is below the market value of the human resource, while a coupon put would normally be exercised only when the strike price is above the market value. When a coupon is exercised, the cost to the buyer of the asset acquired is the strike price plus the premium, if any. When the coupon expiration date passes without the coupon being exercised, then the coupon expires and the buyer would forfeit the premium to the seller. In any case, the premium is income to the seller, and normally a capital loss to the buyer.

The owner of a coupon may on-sell the coupon to a third party in a secondary market, in either an over-the-counter transaction or on the Eridanus Board of Securities Exchange. The market price of a coupon normally closely follows that of the underlying human resource, being the difference between the market price of the human resource and the strike price of the coupon. The actual market price of the coupon may vary depending on a number of factors.

Motivations

Synthetics were the large majority of the empire's work force before the war against the artificials. Once the order to expunge all the synthetics was given, the economy effectively came to a standstill. Large manufactures sit idle with no one to work in the factories. The supply of manufactured goods evaporated, and prices of even basic necessities like soy-proteins had hiked astronomically. Businesses and services that were not essential needs for survival began falling bankrupt.

Now the sector is experiencing a painful deleveraging. Planetary governments are forced to liquidating underutilized assets and reintroduce the population to work they had not performed before and are far inferior at their new jobs compared to their synthetic predecessors. The lack of labor and the overabundance of jobs has planners throwing people to whatever positions need filling, even if the person being promoted is not the best fit for the job.

Eridanii efficiency has kept Tiber afloat even in these times, but the rest of the sector is far from where it once started. The Triumvirate have been reluctant to provide any form of tax break or economic stimulus, fearing that any wrong touch on this frail economy might fully break it. The Texarchs released a proposal on April 22nd, 3200 for a new asset that would help facilitate the trade of labor in an effort to have noble lords coordinate their labor to where it was needed most. After review and approval from the office of the Taxarch, the Vassal Coupon Contract was drafted and the full implementation and trading of this security will begin on June 3rd, 3200. The exchange and fulfillment of standardized contracts will be handled on the Eridanus Board of Securities Exchange.

Contract Specifications

A Vassal Coupon Contract is a contract between two counterparties with the terms of the coupon specified in a term sheet. Coupon contracts may be quite complicated; however, at minimum, they usually contain the following specifications:^[7]

• whether the coupon holder has the right to buy (a coupon call) or the right to sell (a coupon put)
• the quantity and class of the human resource (e.g., 100,000 white-collar laborers from Haqani )
• the strike price, which is the price at which the underlying transaction will occur upon exercise
• the expiration date, which is the last date the coupon can be exercised
• the settlement terms, for instance whether the writer must deliver the actual asset on exercise, or may simply tender the equivalent amount in credits
• the terms by which the coupon is quoted in the market to convert the quoted price into the actual premium – the total amount paid by the holder to the writer

Coupon Trading

Forms of Trading

Exchange-Traded Coupons

Exchange-traded Coupons are a class of exchange-traded derivatives. Exchange-traded coupons have standardized contracts, and are settled through the Eridanus Board of Securities Exchange. Since the contracts are standardized, accurate pricing models are often available.

Over-the-Counter Coupons

Over-the-counter coupons are traded between two private parties, and are not listed on an exchange. The terms of an OTC coupon are unrestricted and may be individually tailored to meet any business need. In general, the coupon writer is a well-capitalized institution or a landed noble (in order to prevent the credit risk).

By avoiding an exchange, users of OTC coupons can narrowly tailor the terms of the coupon contract to suit individual business requirements. In addition, OTC coupon transactions generally do not need to be advertised to the market. However, OTC counterparties must establish credit lines with each other, and conform to the clearing and settlement procedures set in place by House Crux's regulatory body.

Exchange Trading

The most common way to trade Vassal Coupon Contracts is via standardized coupon contracts that are listed on the Eridanus Board of Securities Exchange. Listings and prices are tracked and can be looked up by ticker symbol. By publishing continuous, live markets for coupon prices, the exchange enables independent parties to engage in price discovery and execute transactions. As an intermediary to both sides of the transaction, the benefits the exchange provides to the transaction include:

• Fulfillment of the contract is backed by the credit of House Eridanus,
• Counterparties remain anonymous,
• Enforcement of market regulation to ensure fairness and transparency, and
• Maintenance of orderly markets, especially during fast trading conditions.

Basic Trades

These trades are described from the point of view of a speculator. If they are combined with other positions, they can also be used in hedging. A coupon contract in the Eridanus exchange usually represents 100,000 persons of the underlying human resource.

Long Coupon Call

A trader who expects a precinct's human resource to increase can buy a coupon call to purchase the human resource at a fixed price ("strike price") at a later date, rather than make purchase outright. The credit outlay on the coupon is the premium. The trader would have no obligation to buy the human resource, but only has the right to do so at or before the expiration date. The risk of loss would be limited to the premium paid, unlike the possible loss had the human resource been bought outright.

The holder of a coupon call can sell his coupon holding at any time until the expiration date, and would consider doing so when the GDP per Capita is above the strike price, especially if he expects the price of the coupon to drop. By selling the coupon early in that situation, the trader can realize an immediate profit. Alternatively, he can exercise the coupon — for example, if there is no secondary market for the coupon — and then sell the human resource, realizing a profit. A trader would make a profit if the strike price of the human resource rises by more than the premium. For example, if the strike price is 100 credits and premium paid is 10 credits, then if the strike price of 100 credits rises to only 110 credits the transaction is break-even; an increase in human resource price above 110 produces a profit.

If the price at expiration is lower than the strike price, the holder of the coupon at that time will let the call contract expire and only lose the premium (or the price paid on transfer).

Long Coupon Put

A trader who expects a precinct's GDP per capita to decrease can buy a coupon put to sell the human resource at a fixed price ("strike price") at a later date. The trader will be under no obligation to sell the human resource, but only has the right to do so at or before the expiration date. If the price of the human resource at expiration is below the strike price by more than the premium paid, he will make a profit. If the price of the human resource at expiration is above the exercise price, he will let the put contract expire and only lose the premium paid. In the transaction, the premium also plays a major role as it enhances the break-even point. For example, if exercise price is 100 credits, premium paid is 10 credits, then a price of 100 to 90 is not profitable. He would make a profit if the spot price is below 90.

It is important to note that one who exercises a coupon put, does not necessarily need to own the underlying asset. Specifically, one does not need to own the underlying human resource in order to sell it. The reason for this is that one can short sell that underlying resource.

Short Coupon Call

A trader who expects a precinct's GDP per capita to decrease can sell, or "write", a coupon call. The trader selling a coupon call has an obligation to sell the human resource to the coupon buyer at a fixed price ("strike price"). If the seller does not own the human resource when the coupon is exercised, he is obligated to purchase the human resource from the market at the then market price. If the price of the human resource decreases, the coupon writer will make a profit in the amount of the premium. If the price of the human resource increases over the strike price by more than the amount of the premium, the seller will lose money, with the potential loss being unlimited.

Short Coupon Put

A trader who expects a precinct's GDP per capita to increase can sell, or "write", a coupon put. The trader selling a coupon put has an obligation to buy the human resource from the coupon buyer at a fixed price ("strike price"). If the price of the human resource at expiration is above the strike price, the coupon writer will make a profit in the amount of the premium. If the price of the human resource at expiration is below the strike price by more than the amount of the premium, the trader will lose money, with the potential loss being up to the strike price minus the premium.

Strategies

Combining any of the four basic kinds of coupon trades (possibly with different strike prices and maturities) and the two basic kinds of human resource trades (buying or selling the right of lordship) allows a variety of coupon strategies. Simple strategies usually combine only a few trades, while more complicated strategies can combine several.

Strategies are often used to engineer a particular risk profile to movements in the market economy. For example, buying a butterfly spread (long one X1 call, short two X2 calls, and long one X3 call) allows a trader to profit if the price of the human resource on the expiration date is near the middle exercise price, X2, and does not expose the trader to a large loss.

Valuation

Coupon valuation is a topic of ongoing research in academic and practical finance. In basic terms, the value of a coupon is commonly decomposed into two parts:

• The first part is the intrinsic value, which is defined as the difference between the market value of the underlying, and the strike price of the given, coupon
• The second part is the time value, which depends on a set of other factors which, through a multi-variable, non-linear interrelationship, reflect the discounted expected value of that difference at expiration.

Risks

As with all securities, trading Vassal Coupon Contracts entails the risk of the coupon's value changing over time. However, unlike traditional securities, the return from holding a coupon varies non-linearly with the value of the underlying and other factors. Therefore, the risks associated with holding coupons are more complicated to understand and predict.

Eridanii Quants are currently at work forming a valuation model that account for not just intrinsic and time variables, but physical ones as well. This includes variables such as the age, health, gender, education, and fitness of the human resource. With the help of the DELPHI system the valuation model could even identify sexual preference, personality, eating schedules, political leanings, recreational activities and spending habits as important indicators that affect the value of a coupon contract.

For the time being, coupon valuations are evaluated with a combination of Black-Scholes and Stochastic volatility models.

Pin Risk

A special situation called pin risk can arise when the underlying closes at or very close to the coupon's strike value on the last day the coupon is traded prior to expiration. The coupon writer (seller) may not know with certainty whether or not the coupon will actually be exercised or be allowed to expire. Therefore, the coupon writer may end up with a large, unwanted residual position in the underlying when the markets open on the next trading day after expiration, regardless of his or her best efforts to avoid such a residual.

Counterparty Risk

A further, often ignored, risk in derivatives such as coupons is counterparty risk. In an Vassal Coupon Contract this risk is that the seller won't sell or buy the underlying human resource as agreed. The risk can be minimized by using a financially strong intermediary able to make good on the trade, but in a major panic or crash the number of defaults can overwhelm even the strongest intermediaries. Thankfully, Crux enforcement has yet to fail in enforcing fulfillment in derivative contracts and are unlikely to do so with VCCs.

Enforcement and Delivery

Should any buyer wish to exercise their coupon for the purchase or sale of the human resource, a series of actions occur.

First, the Coupon is redeemed and both counterparties are reinforced of their rights and obligations set forth by the contract. Any regulatory ordinance placed by House Crux will take precedence above the rules and limitations set by the contract. Any special clauses made in OTC Coupons will be put into effect immediately on delivery of notice. Both parties must immediately adhere to these rules and obligations or face legal repercussions.

Next, the payment for the human resource is collected from the purchaser and put into escrow. This payment will remain in escrow until proof of delivery of the Human Resource. Should the purchaser not have the required balance to make the purchase, House Eridanus will act on their right to seize the purchaser’s assets and liquidate them to pay for the obligation. The purchaser will furthermore be fined 300,000 credits for breaching the terms of the contract. Should the purchaser still not hold enough credits after liquidation, they shall be bankrupt with all credit lines cut and shall be held liable and accountable for damages and the capital loss on the part of the counterparty. Penalties can include further fines, 15 years of prison, and become the Debitrix to the counterparty.

The seller of the human resource must then collect and then deliver the human resource to the purchaser. The assets delivered must be in the full quantity as put forth in the contract and in the correct class of human resource as put forth in the contract. The deliverable must be insured against damage and loss In transit to the Purchaser. House Eridanus will not be held liable in any instance. Delivery of the human resource to the purchaser is to be made in 6 months from the date the Coupon is exercised on standardized contracts traded on the Eridanus Board of Securities Exchange. The delivery date on OTC Coupons can vary and will be determined by both counterparties at the creation of the contract.

The seller is responsible for the policing of their subjects to comply with the procedures of the transaction. It is in House Crux’s discretion whether or not to provide assistance and consultation to the seller in the process of completing the transaction. It is advised of the seller to attempt to keep family units within the deliverable together in the exchange if possible, but is not necessary.

Should the seller not have the correct quantity and/or class of the human resource, the seller is responsible to purchase the required human asset on the open market at the market price to make up for the deficit. Should the seller still not have the deliverable by the due date set forth in the contract, they are to pay to the purchaser the difference in debt plus an Inconvenience fee of 10% of the market cost of the remaining total of human resource or 5,000 credits, whichever is more. Should the seller not have the required balance to pay the difference and fee, House Eridanus will act on their right to seize the seller’s assets and liquidate them to pay for the obligation. The seller will furthermore be fined 300,000 credits. Should the seller still not hold enough credits after liquidation, they shall be bankrupt with all credit lines cut and shall be held liable and accountable for damages and the capital loss on the part of the counterparty. Penalties can include further fines, 15 years of prison, and become the Debitrix to the counterparty.

Finally, at delivery of the human resource to the purchaser, an Eridanii official will asses the human resource delivered to confirm that it meets the contract’s specifications. If so, the funds in escrow will be delivered to the seller minus a 1% holding fee paid to House Eridanus. If the human resource delivered is determined to not be sufficient to meet the contract’s requirements, the seller is fined 5,000 credits and must deliver the correct amount and class of human resource before the due date or face the repercussions as stated above.