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Strategies & Market Trends : Mish's Global Economic Trend Analysis

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To: YanivBA who wrote (54643)	8/10/2006 9:20:55 PM
From: YanivBA	of 116555

CDS Settlement types Credit Default Swaps and Trade: a Useful Tool for Distributing Risk By Stacey Facter, Vice-President and Head of Global Trade Distribution & Insurance JPMorgan Chase Treasury Services jpmorganchase.com ... There are two types of settlement when credit default swaps are used: cash and physical. * Cash Under a cash settlement, there is no delivery of the reference obligation. A market auction of the reference obligation takes place after the credit event occurs, the benefits of which go to the protection buyer. The seller of protection then makes a cash payment to the buyer for the difference, if any, between the calculation amount and the recovery value of the reference obligation. * Physical Under a physical settlement, subject to receipt of any required consents, the buyer of protection delivers title to its claim against the reference entity to the seller of protection. The provider of protection then has a claim on the reference entity. The provider of protection then makes a cash payment to the buyer of protection for the calculation amount (i.e., nominal value of the bonds) less any accrued fee payable. Ok, what I have learnt? 1. There is such a thing as a CDS cash settlement contract. 2. The settlement price is set in the bond auction that follows the credit event. Conclusion: the cash delivery CDS contract is built so that once the CDS market is oversaturated with physical delivery contracts it does not make any difference which is the type of contract an investor holds. A naked physical delivery investor will have to buy a bond in the same auction that sets the price at which the cash delivery contract would be settled. Even if the market is not saturated with physical delivery there is no difference between the two delivery methods. In a saturated market both are worth zero. In an unsaturated market both are worth the credit risk. YanivBA.

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