Let's make a real bet...

[KrazyHorse]

CDS is useful even for those who do not hold the associated debt, dude.

The real problem is that these are virtually all OTC contracts, so when Lehman went (and AIG threatened to go) people saw all their beautiful hedging destroyed.

[KrazyHorse]

Originally posted by Naked Gents Rut
Christ, at 3000 bp I'd end up paying you $3,000 for credit protection on $2000 if Pakistan doesn't default in the next 5 years. **** that. Let's just agree on the geometric mean of 75 and 3000.

Unlike some people I know I do not claim to hold wildly wrong views on certain probabilities.

[KrazyHorse]

Originally posted by Naked Gents Rut
Christ, at 3000 bp I'd end up paying you $3,000 for credit protection on $2000 if Pakistan doesn't default in the next 5 years. **** that. Let's just agree on the geometric mean of 75 and 3000.

Those CDS are for much shorter terms than that. That's why the annualized rate is so high. There is a large probability of default in the near future, and much lower as you get further out.

[Naked Gents Rut]

CDS is useful even for those who do not hold the associated debt, dude.

Very true.

Those CDS are for much shorter terms than that.

Do you have any idea how short? I know 1 year was the usual minimum back in the good old days (say July), but who knows what's going on now.

[KrazyHorse]

If you only knew the scale of notional value of interest-related swaps you would piss yourself...

[KrazyHorse]

My favourite is that IBs were making money shaving 5 or 10 bps out of the middle of an interest rate swap (say fixed to floating) and purchasing CDS protection on both sides. And this made people billions of dollars.

[Naked Gents Rut]

Originally posted by KrazyHorse
If you only knew the scale of notional value of interest-related swaps you would piss yourself...

The notional amount of CDS was $45.46 trillion in June 2007. That represented growth of 75% over the $26 trillion in June 2006. Was only $1.56 trillion in June 2002. That's insane.

Or are you talking about overnight interest rate swaps?

edit:

The notional amount outstanding as of December 2006 in OTC interest rate swaps was $229.8 trillion, up $60.7 trillion (35.9%) from December 2005. These contracts account for 55.4% of the entire $415 trillion OTC derivative market.

Wow.

[Darius871]

Originally posted by KrazyHorse
CDS is useful even for those who do not hold the associated debt, dude.

In what way other than a net profit for the third-party gamblers? (Maybe I just answered my own question...)

Originally posted by KrazyHorse
The real problem is that these are virtually all OTC contracts, so when Lehman went (and AIG threatened to go) people saw all their beautiful hedging destroyed.

Why would a central exchange make so much difference as opposed to OTC? The exchange wouldn't guarantee the contracts and just provides a more standardized medium for their creation, which means the utter collapse of a holder like Lehman or AIG would still render the contract uncollectable. Even regulating CDS's in the same way as insurance wouldn't change the fact that the insurer can go bankrupt at any time.

Finance =

[KrazyHorse]

Originally posted by Naked Gents Rut
Do you have any idea how short? I know 1 year was the usual minimum back in the good old days (say July), but who knows what's going on now.

Probably the same now, then. Don't know specifics of that market.

But I bet you that you can get a 2 year contract for not much more than half of 3000.

[Naked Gents Rut]

In what way other than a net profit for the third-party gamblers? (Maybe I just answered my own question...)

Say you have a lot of business with a firm, but don't hold any of its debt. You'll obviously be hurt if that firm goes bankrupt, so you buy credit protection against them. If they go under, you go buy some bonds on the secondary market and use them to exchange for your credit protection payment.

[KrazyHorse]

Originally posted by Darius871

Why would a central exchange make so much difference? It doesn't guarantee the contracts

Yes it does.

the utter collapse of a holder like Lehman or AIG would still render the contract uncollectable.

Margin, margin, margin.

Exchanges require margin so that even if the holder of one side of a contract goes belly up there is enough in the margin account to cover the other side.

Now, the exchange will have to close out its position, but it's supposed to be well-capitalized enough that the collapse of any single party on a single day will not be enough to drive the exchange into insolvency.

[KrazyHorse]

Contracts made on an exchange have the exchange as counterparty, not the other side of the contract.

[Darius871]

Originally posted by Naked Gents Rut


Say you have a lot of business with a firm, but don't hold any of its debt. You'll obviously be hurt if that firm goes bankrupt, so you buy credit protection against them. If they go under, you go buy some bonds on the secondary market and use them to exchange for your credit protection payment.

Why not just make that firm's directly obtaining credit protection, and proportional assignment thereof, conditions of your contract(s) with them? Saves the hassle.

[Naked Gents Rut]

Now, the exchange will have to close out its position, but it's supposed to be well-capitalized enough that the collapse of any single party on a single day will not be enough to drive the exchange into insolvency.

Not sure that would've worked in the case of AIG. They sold an insane amount of super-senior CDS on structured investment vehicles.

[KrazyHorse]

AIG wouldn't have been able to sell that many CDS if they'd been required to post margin...