As described in a previous FarmDoc Daily article, MF Global failed on Oct. 31, 2011 with a shortfall in customer funds of $1.2 billion (since increased to $1.6 billion) affecting approximately 38,000 futures accounts. A large percentage of these accounts were held by individuals and entities in the agricultural sector.

The bankruptcy trustee has returned approximately 72¢ of every dollar that should have been in those customer accounts at the time of the failure. The outcome of the remaining 28¢, which combined across all 38,000 accounts adds up to that billion-dollar-plus figure, is still an open question. The deadline for former customers to file formal claims with the bankruptcy court was Jan. 31. However, recent news reports indicate a number of firms have stepped forward and are offering to buy the bankruptcy claims of former MF Global customers.

The purchase of outstanding claims by some third party is a fairly common practice. There is an active trade in the buying and selling of certain types of insurance settlements and court judgments. A related practice involves the purchase of multi-year lottery payments for a single lump sum. The selling point used in all of these activities is that the buyer assumes all the risk and uncertainty, and the seller (in this case, a former MF Global customer waiting to receive some type of payment through the bankruptcy court) receives a payment from the buyer right away (within seven to 10 business days, in the case of former MF Global customers).

In return for assuming this risk of a payout from the bankruptcy process and for making immediate payment, the buyer pays the seller some discounted amount of the full claim. This discount represents the time value of money on the payment, plus some factor representing the probability that the claim will be paid, either in full or in part. For lottery payments and other types of annuities this calculation is fairly straightforward, and it is relatively simple to determine the so-called “fair value” of a future payment or series of payments.

For example, the Illinois State Lottery “Lotto” game pays a minimum of $2 million to a single winner in 26 equal annual payments: the first payment now, and additional payments each year for the next 25 years. If there is no risk that each of those annual installments will be paid, then the only information needed to find the fair value are the amount of each payment ($2 million divided by 26), the number of years until the final payment is received (25), and an interest rate (long-term Treasury bonds are currently yielding around 2.75%). Using this information and a standard formula, $2 million paid over the next 25 years would be worth about $1.46 million if paid in a single lump-sum payment today.