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Politics : GOPwinger Lies/Distortions/Omissions/Perversions of Truth -- Ignore unavailable to you. Want to Upgrade?

To: Kevin Rose who wrote (139354)	9/29/2008 8:18:16 PM
From: Lizzie Tudor	1 Recommendation Read Replies (1) \| Respond to of 173976

because that is how they are sold Kevin. The people who work in these treasury offices here are not bond kings like Bill Gross. Somebody says something is AAA rated, and offers you a credit default swap to hedge, you think you are protected. Hedging Credit default swaps can be used to manage credit risk without necessitating the sale of the underlying cash bond. Owners of a corporate bond can protect themselves from default risk by purchasing a credit default swap on that reference entity. For example, a pension fund owns $10 million worth of a five-year bond issued by Risky Corporation. In order to manage the risk of losing money if Risky Corporation defaults on its debt, the pension fund buys a CDS from Derivative Bank in a notional amount of $10 million that trades at 200 basis points. In return for this credit protection, the pension fund pays 2% of 10 million ($200,000) in quarterly installments of $50,000 to Derivative Bank. If Risky Corporation does not default on its bond payments, the pension fund makes quarterly payments to Derivative Bank for 5 years and receives its $10 million loan back after 5 years from the Risky Corporation. Though the protection payments reduce investment returns for the pension fund, its risk of loss due to Risky Corporation defaulting on the bond is eliminated. (However, the fund still faces counterparty risk if Derivative Bank becomes insolvent and cannot honor the CDS contract). If Risky Corporation defaults on its debt 3 years into the CDS contract, the pension fund would stop paying the quarterly premium, and Derivative Bank would ensure that the pension fund is refunded for its loss of $10 million (either by taking physical delivery of the defaulted bond for $10 million or by cash settling the difference between par and recovery value of the bond). Another scenario would be if Risky Corporation's credit profile improved dramatically or it is acquired by a stronger company after 3 years, the pension fund could effectively cancel or reduce its original CDS position by selling the remaining two years of credit protection in the market. en.wikipedia.org