 Hey guys, it's MJ the student act tree and in this video I want to show you how to turn your friends loans into triple a securities Now I must just give a little warning what I'm about to show you Might be illegal in your own country without proper license and regulations and all that stuff So just bear that in mind when we go through this video The big motivation for this video is I subscribe to this guy called the king of random And he does all these how-to videos and I absolutely love them Specifically he's one on how to make proto patty Although when I tried to do it. Yeah, I just made a made a big mess So instead I wanted to do a video like him So this video is basically how to make your own triple a security and what you're gonna need for this video is You're gonna need say around three friends and you're gonna be needing to to make the following Assumptions so what you want to do is you want to give a hundred dollars to three of your friends and you need to well hopefully Give it to friends and let's say they have a 90% chance of paying you back the loan Very important assumption to make is that all your friends are also independent So if the one doesn't pay It doesn't have any impact on whether the other person will pay now What we're gonna be doing is we're gonna be taking those three friends loans And we're gonna be dicing them up chopping them up and creating our very own security so we're gonna be making three types of securities and Green means it's gonna be very like hardly any risk and reds means there's gonna be lots of risk So for our green security Which we're gonna show is gonna be triple a rated What the contract says is that we're gonna take those three friends and we're gonna group them together And what we're gonna say is that if just one of them has to repay in order for this contract to pay out so what you would do with this contract is it's a hundred dollars and This contract will get us money back if just one of the three people repay their loan Which means what is the risk? Well, the risk for this one is that if all three of the friends Default remember there's a 10% chance that each of the friends default So and because we're assuming independence the probability that all three of them default and that you absolutely lose this This investment is incredibly small, which means that it has a 99.9 percent chance of Repaying and like I said that is triple a rated. So that is perfection over there Now the middle one is we can have the rule that say just two of them have to repay Now the mathematics for this one gets a little bit more complicated because you know There's gonna be you know a little bit of combination and permutation functions going on But essentially it breaks down to having a security of 97.2 percent Which we'll see is around a triple B or even an a rated type of bond Now what we're basically doing is we're transferring all the risk Out of these contracts and putting them into the red one So the red one works or the red one will only repay if all three of the friends You know don't default which means the mathematics is 90% to the power of three, which means There's only a 72.9 percent chance that this Security will not default which kind of gives it that junk status Okay so now Basically just to recap before what we had were three friends were three loans of a hundred dollars each and Each of them had a 90% chance of repa of repaying After we've done our little Actorial magic what we have now are we have three other? Securities both all three of them are also a hundred dollars remember no money's just being created or destroyed But what we've done is we've repackaged the risk across these three contracts and Like I said before the green one is now triple a rated the middle ones will be a B Rating and the final one will be like around a C rating Now the whole reason is why on earth would we want to do this? You're probably watching this video and being like what's what's the point of this? Well, this is when the economics comes in because of this whole thing known as supply and Demand okay, what we have in the world is we have these things called pension funds now pension funds have got Trillions of dollars. That's right. I used the t-word Trillions of dollars under management however, pension funds are only allowed or a big chunk of their money has to go into triple a Rated securities so if your friends wanted to get a loan from a pension fund they would go mm-hmm We can't have you. Sorry go away However by taking your three friends and dicing and repackaging their risk You can now actually sell your friends loans to a pension fund and because they're such a very limited supply of pure triple a bonds Due to supply and demand you can fetch a much better price for your green contract however, you can't just pocket all of that extra price because you might want to Make the red one a little bit more attractive because not many people are going to be wanting this one However, if you take the profit that you make of the green one and you subsidize this one a little bit Then you're definitely going to be getting the attention of hedge fund managers and you will actually be able to Pass this entire instrument onto them so basically what you've done is you've taken advantage of the inefficiencies created through regulation and By doing this you can actually it can actually be quite profitable all essentially all you're doing is you're taking loans You chopping them up. You're repackaging them selling them off. You're taking advantage of the supply and demand curve and essentially you can make Millions and millions if not trillions of dollars because you know, there's all these percentages that you can make on the loans And Joe that that is my little how-to video So this is actually how to make your own triple a rated bonds. It's not as entertaining as the king of random I actually love his channel. So go check it out But oh, I almost forgot to promote my book. So if you enjoyed this video I have written a little mini textbook on understanding, you know financial instruments with simple diagrams This part of the book I kind of focused on chapter 3, you know, run mortgage-backed securities and all of that So I will put a link in the description below You guys can go and buy my book on Amazon. Okay, that's all I needed to say Thanks so much for watching and I'll see you guys for the next video. Cheers