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.
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 …
Our firm [and I am sure many brokerage firms] are witnessing a conundrum in the market which is causing both clients and the broker a huge amount of heartache. It is that of the ‘AIP’ or ‘Approval In Principle’ not being honoured by banks over short periods of time. One lender in particular [we can’t name names] is doing that on so many cases that we no longer consider their approvals as holding any relevance.
What is an approval in principle (A.I.P. is the broker-speak we use to describe them)? It generally means that you have given a bank enough information to make a strong [and yet preliminary] decision on a case, sometimes it is subject to further documentation, or they want to get a valuation report before making a full offer, in any case an AIP is NOT a loan offer but it is as strong an indication as one can get without dealing with solicitors, in the past an AIP was honoured almost exclusively and they were seen as fundamental to …
I had an interesting conversation with an Estate Agent recently who has been in the industry for over thirty years and he said that he felt he was seeing the ‘end of ownership’ in the young people today. That really got me thinking.
‘What do you mean by that?’ I naturally enquired, and basically he said that he was seeing a trend in young people not feeling any incentive to buy a house, not only in the short term but ever, ‘why would they buy, kit a place out and go to all the expense when they can just rent a place ready to go and any problem is the landlords?’ was his response. And one must admit that there is a large dose of common sense in that. Renting is no more dead money than mortgage interest is dead money, however, what it could mean for the future is that we become a nation of landed and un-landed citizens, which is ironic given that land ownership has played such a strong part in …