Everyone is the winner

Sejahtera Manufacturing has a project valued Rp1 billion with Rp300 million expected return and then borrows from IndoBank.

Sejahtera's Rp1 billion loan at Rp150 million interest to IndoBank is protected with Rp100 million from Suwito Corp for a maximum Rp500 million default.

There's no reason for IndoBank to not give the loan to Sejahtera Manufacturing since its profit is still Rp50 million after the protection cost.

Suwito expects that the default may not be more than Rp 100 million so that he can profit from the protection revenue. As he worries, he then buy protection from Buyung Corp at Rp20 million for a maximum Rp100 million default. Suwito can now secure his income from the Rp100 million protection paid by IndoBank.

We can say that Buyung may be the loser because he needs to cover Rp100 million if Sejahtera defaults while only receiving Rp20 million from Suwito.

The secret of this transaction is that Buyung Corp has already owned a majority of Sejahtera's shares and bet on Sejahtera's prospect that could achieve at least Rp200 million return. Paying Rp150 million interest to IndoBank and receiving Rp20 million protection plus Rp200 million return, Buyung and Sejahtera still pocket Rp70 million net profit.

Every transaction is based on the perceptions of the probability and likelihood of default among the players.

IndoBank's perception is a default by Rp500 million that needs to be protected with Rp100 million. Suwito's perception is a default by Rp100 million that needs to be protected with Rp20 million. Meanwhile, Buyung has no perception of default at all since he knows the situation of the project.

Buyung must have a larger size of business in order to help Sejahtera’s project from default. This kind of help usually comes when the project is already underway and seems to have some issue but still prospective.

Who is the biggest winner here? IndoBank gets Rp50 million, Buyung and Sejahtera share Rp70 million and Suwito collects Rp100 million, so Suwito is the biggest winner.

Why is that? The first bettor on uncertainty normally enjoys the biggest return.


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