Credit Default Swap What are Credit Default Swaps

Credit Default Swap What are Credit Default Swaps a. Exchanging credit with a family member to get a better loan rate b. Betting that a corporation will not pay back it’s loan c. Trading your bank home loan with a Government backed loan.

CDS ► CDS – Credit default swap ► It is sort of like an insurance policy similar to private mortgage insurance except for some major differences. § How much would a 1% PMI be a year on a $200, 000 home?

CDS analogy Chris Purchased a home for 200, 000 but had no money to make a down payment. ► You understand that he would need to purchase private mortgage insurance to protect the bank against default. ► $200, 000 *. 01 = $2, 000 per year ► $2, 000/12 = $167 per month ► Now in the home analogy Chris is paying this $167. In the CDS world ANYONE CAN. ► I could take out a PMI on Chris for $167. I get nothing unless he defaults on his loan. Although, if he defaults, I get $200, 000. ►

CDS ethics ► Would you take out a policy gambling that Chris would not pay his home loan?

CDS example ► Chase Bank took out a $2. 2 B loan with the federal government to cover their gambling losses for 2 weeks ago. ► The government make $100, 000 in interest every month. ► The government can take out a CDS on the loan for $50, 000 per month.

A CDS cuts into profit ► The government was making $100, 000 per month. ► If they take the $50, 000 CDS policy, they will lose half of their profit. ► Would you advise the government to take the CDS?

What is the biggest disadvantage with a CDS ► A. They cut into profit revenue. ► B. They create a feeling of distrust between banks and corporations. ► C. You are gambling against success.

What is the biggest advantage with a CDS ► They guarantee some money to be made even if it is less money. ► There is a chance to make a huge windfall of money ► You like hoping that others will fail.