Credit Default Swaps (CDS’s) are an over the counter (not bought or sold through an exchange) product which gives the buyer insurance in the case of a credit event (default) of the underlying (reference entity: often a bond). Effectively this brings together a long and short. The video below does a good job of explaining much of this, well worth watching.
From a credit perspective that is. The picture below is a snapshot of Credit Default Swap prices and the Cumulative Probability of Default (CPD) by CMA Vision.
Europe is making a comeback in the ‘basket-case economies’ league tables, Ireland is playing third fiddle to Venezuela and Greece, unthinkable yet real.
This may be an hour long, but it is well worth it as you are getting to hear from one of the top bank analysts in the USA, Meredith Whitney didn’t just say ‘something is going to happen’, she predicted specific bank movements, including that Citi would have to slash it’s dividend or go broke.
Sometimes talking about present values, par and yield to maturity will catch even a well versed practitioner off guard, but to see a pricing model in action helps and that is precisely what this video does – in this clip an assumed future rate is discounted into present values and we arrive at the bond price. Well worth watching (twice!).
If you understand that life assurance is something you take out in case you die then I am hopeful that we can help you come to terms with credit default swaps. A retail banking example would be where (hypothetically) a bank takes out a life assurance on a borrower so that if they die the loan is repaid.
This doesn’t happen in real life but it makes the point, that a person with a credit risk on their book (the borrower is a credit risk to the bank) can hedge against (take out life assurance) loss (non-repayment of the loan) via the borrower (reference entity) in the event of their death (credit event), quite a mess of parenthesis in that sentence!
A CDS is an insurance against credit risk, it is a privately negotiated bilateral contract. The buyer pays a fixed fee or premium to the seller for a period of time and if a certain ‘credit event’ occurs the protection seller pays the buyer.
A ‘credit event’ can be a payment default or bankruptcy of the company or country …
Two world renowned commentators give their views on the economy and market. The points they are making are that the same people are in charge, the system is not fundamentally changing, and that drastic measures are required in order to solve the financial crisis.
The main points made are that cash is king, the bottom has not fully been reached, and that we need to change the way the economy is driven, we need to get back to real physical capital rather than unproductive activities such as housing and finance.
This is an interesting clip about Credit Default Swaps and how they work, CDS’ are something that have been mentioned more and more in the papers and they are are derivatives market product.
Sometimes these words get bandied about like everybody should know what they are about, the truth is not everybody is a finance nerd and getting some simple examples is probably the best way to come to grips with these concepts, enjoy!
Hedge funds, often portrayed as murky operations managing billions upon billions and working offshore with managers earning €100,000,000 a year. The truth is a little different, like in any industry the very top people make exceptional livings doing what they do, the average hedge fund is based around people working hard, and trying to ‘hedge’ their bets, or the bets of their clients.
However, this week at a hearing on the Hill, while being grilled by Congress they agreed that they “see the benefits greater transparency can bring to maintaining stable economies and a healthy global financial system”. It is probably worth talking about hedgefunds and what they do.
The concept is relatively simple, you buy long and short positions. ‘Long’ means that you buy it because its a good stock, or it has good dividend or it is undervalued etc. it is based on the same traditional reason you would buy any stock. ‘Short’ is the reverse, you can buy and sell shares, you can also sell and then buy, …