savageinfidel

Jim Mahar over at FinanceProfessor.com just linked to a fantastic explanation of Credit Default Swaps. Here's the opening lines: Credit default swaps (CDSs) have been identified in media accounts and by various commentators as sources of risk for the institutions that use them, as potential contributors to systemic risk, and as the underlying reason for the bailouts of Bear Stearns and AIG. These assessments are seriously wid e of the mark. They seem to reflect a misunderstanding of how CDSs work and how they contribute to risk management by banks and other intermediaries. In addition, the vigorous mark et that currently exists for CDSs is a significant source of market-based judgments on the credit conditions of large numbers of companies--information that is not publicly available anywhere else. Although the CDS market can be improved, excessive restrictions on it would create considerably more risk than it would eliminate. It also has a very nice diagram of a typical CDS (and ...

There's been a lot of talk in recent months about "synthetic debt". I just read a pretty good explanation of synthetics in Felix Salmon's column, so I thought I'd give a brief summary of what it is, how it's used, and why. First off, let's start with Credit Default Swaps (CDS). A CDS has a lot of similarities to an insurance policy on a bond (it's different in that the holder of the CDS needn't own the underlying bond or even suffer a loss if the bond goes into default). The buyer (holder) of a CDS will make yearly payments (called the "premium"), which is stated in terms of basis points (a basis point is 1/100 of one percent of the notional amount of the underlying bond). The holder of the CDS gets paid if the bond underlying the CDS goes into default or if other stated events occur (like bankruptcy or a restructuring). So, how do you use a CDS to create a synthetic bond? here's the example from Salmon's column: Let's a...

This weekend I posted a video of a "whiteboard" talk by Paddy Hirsch of Marketplace, in which he explains CDO s and the credit crisis. Here's another one where he explains Credit Default Swaps (CDS) using the analogy of an arctic expedition. Since I'm teaching Fixed Income next year, I'm sure some of these will make their way into my class.