tag:blogger.com,1999:blog-4102429195693595750.post5473112872576485584..comments2024-03-22T05:15:17.042+02:00Comments on Sudden Debt: CDS Factors In Equity Valuation - Part DHellasioushttp://www.blogger.com/profile/03564511281240682625noreply@blogger.comBlogger30125tag:blogger.com,1999:blog-4102429195693595750.post-10369553216463457612007-12-12T20:05:00.000+02:002007-12-12T20:05:00.000+02:00My apologies if this question has been answered pr...My apologies if this question has been answered previously, but does anyone have a sense as to the size of the long correlation book? My thought is that if any of these central bank pseudo-bailouts are successful in finding an exit for senior credit-holders, those long correlation will get absolutely hammered.<BR/><BR/>I hope this makes any sense. Thanks and thanks for this excellent blog!<BR/>RichAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-89597312584072514602007-12-10T03:19:00.000+02:002007-12-10T03:19:00.000+02:00re: Hellasious "Let me just ask this: what would ...re: Hellasious <I>"Let me just ask this: what would happen to the CDS market if Morgan or any other major player said it has to take a $50 billion hit to their earnings - for whatever reason?<BR/><BR/>Would you then worry about counter-party risk? Would you pull up your book and look at every single position you have with Morgan - matched or not? What would that mean for the importance of notional, then?"</I><BR/><BR/>jesus i'd probably cr*p myself if i had to try and hedge all my positions to JP, that would take some work!! :)<BR/><BR/><BR/><BR/>and re: al-tannr:<BR/><BR/>a matched book for a CDS dealer would usually mean in the first instance that my "market risk" is pretty much flat, such that if the overall market moved 1 basis point (1bp) either way, I wouldn't make or lose anything...although in reality you can never hedge back to zero, as you'll have a number of trades of different maturities and prices you entered into these trades will pretty much all be slightly different.<BR/><BR/>in the second order, you can look at each credit (company) and try and get the risk as close to zero for that also. but it really is a b*tch to get rid of every little bit of residual risk.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-12261794737091500832007-12-09T13:46:00.000+02:002007-12-09T13:46:00.000+02:00I would appreciate more information on what Hellas...I would appreciate more information on what HellasIOUs called a "matched book." CDS Trader also wrote about low net exposure, even zero for certain cases.<BR/><BR/>How is a "matched book" similar to and/or different from a stock fund which fully hedges using equal long and short positions? Are the CDS positions which are "matched" distributed over different underlying instruments? Or, are they matched against holding/writing a CDS index?<BR/><BR/>Several times over the last few months, some of the most shorted housing-related stocks moved up strongly while the general market drifted down. One explanation was that long/short funds were having to cover their short positions. Do CDS holders have to actively manage their positions to maintain minimal risk? If so, are there potential market dislocations which could make this difficult to do during the day?<BR/><BR/>Thank you for this excellent blog. AlanAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-8217286373642554162007-12-09T02:01:00.000+02:002007-12-09T02:01:00.000+02:00Hellasious,Thanks for pointing out the (dialectica...Hellasious,<BR/><BR/>Thanks for pointing out the (dialectical) contradiction/relation between systemic and micro. Neoclassical econ with its ingrained methodological individualism often prevents people from seeing the macro as anymore than aggregation, so falls into fallacies of composition and analytic failures. <BR/><BR/>Greenie,<BR/><BR/>You note that '[Asian] economic conditions were deteriorating [prior to financial crisis]' and, you know, I've long found it interesting how infrequently this has, at least in the U.S.. been included within analysis, as though it was strictly financial.<BR/><BR/>Please correct if in error but didn't weakening first evidence itself as falling profits (not earnings) in S. Korea, more or less late 1995 - early 1996?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-57315683331766354272007-12-08T01:57:00.001+02:002007-12-08T01:57:00.001+02:00Sorry Hellasious for stealing your thread.Sorry Hellasious for stealing your thread.Greeniehttps://www.blogger.com/profile/16723475560144858107noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-56083112153159907272007-12-08T01:57:00.000+02:002007-12-08T01:57:00.000+02:00But here lie the problem that trigger the whole th...<I><BR/>But here lie the problem that trigger the whole thing -- these countries were running trade deficit due to strong consumerism growth, and their foreign reserves were low. <BR/></I><BR/><BR/>Again, your comparisons are not valid. You cannot compare the current situation of US with four bubbly small Asian countries running trade deficit. A better comparison is UK (i.e. British Empire) from 1880-1930s, when British pound was the reserve currency around the world, and Britain was running trade deficit.<BR/><BR/>The difference between US at present and those small Asian countries of 1998 is that US dollar is the global reserve currency accepted by all central banks in the world. That is where all the power of US comes from. It is not from pricing of oil in dollar or anything like that.<BR/><BR/>When US dollar loses that status (i.e. final collapse of Bretton Woods era), then US becomes equivalent to any other country in the world....and all your expectations will materialize. Until then, stick to Mish. He knows his stuff :)<BR/><BR/><BR/>One more time: horse = US dollar is reserve currency, cart = oil is priced in dollar. Hope this help.<BR/><BR/>P. S. I expect end of dollar reserve era within another 8-10 years. The process has already started.Greeniehttps://www.blogger.com/profile/16723475560144858107noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-89595746719704732202007-12-08T01:44:00.000+02:002007-12-08T01:44:00.000+02:00Well, that is a complete news to me.Check here:htt...<I><BR/>Well, that is a complete news to me.<BR/></I><BR/><BR/>Check here:<BR/><BR/>http://en.wikipedia.org/wiki/Asian_financial_crisis<BR/><BR/>or here:<BR/>http://news.bbc.co.uk/2/hi/asia-pacific/6260720.stm<BR/><BR/>and here is some info on Hong Kong:<BR/>http://www.financeasia.com/print.aspx?CIID=97063Greeniehttps://www.blogger.com/profile/16723475560144858107noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-19381922999621235172007-12-07T22:44:00.000+02:002007-12-07T22:44:00.000+02:00greenie, Well, if I recalled correctly, many stoc...greenie,<BR/><BR/><I> < Their economic conditions were deteriorating > </I><BR/><BR/>Well, if I recalled correctly, many stock market index were near record highs.<BR/><BR/>I recalled reading banks in Hong Kong offered 0% deposit rate. Also, the banks would Charge service fees if you deposit money in the banks. So essentially if you were in HK, then putting money into a bank will cost you negative returns. <BR/><BR/>Credit were loose, times were good.Shawnhttps://www.blogger.com/profile/08155630920582744324noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-24530393315601903452007-12-07T22:38:00.000+02:002007-12-07T22:38:00.000+02:00greenie, Well, that is a complete news to me.As f...greenie,<BR/><BR/><I> < Asian countries tried to peg their currency to a fixed exchange rate ... their economic conditions were deteriorating ... > </I><BR/><BR/>Well, that is a complete news to me.<BR/><BR/>As far as I remembered, and vividly, the Asian currency were traded freely. At least that was my daily news for South East Asia of Thailand/Malaysia/Indonesia. <BR/><BR/>There was no pegging of currency. That happened only after the financial crisis. <BR/><BR/>These countries, if I remembered correctly, were enjoying strong economic boom (now I am not to argue if this is similar to NASDAQ 2000 before bubble burst that economic situations were "hiddnely" getting worse).<BR/><BR/>Not only were their economic growth were strong, but there were talks as if South East Asia would become the previous version of Asian 4 Tigers or Dragons -- Singapore/Taiwan/Seoul/Hong Kong. <BR/><BR/>But here lie the problem that trigger the whole thing -- these countries were running trade deficit due to strong consumerism growth, and their foreign reserves were low. <BR/><BR/>Once the Asian crisis hit, and you see everything went in Complete Reverse:<BR/><BR/>1) No more free forex trading, as currency was begin to be pegged. Repeat, I did not hear about Currency-Peg thing ever until after the crisis started and asian currency was dropping everyday, causing import/export business to collapse due to unknow future price point.<BR/><BR/>2) Internal consumerism collapse, and was replaced by export orientation. This lead to 3rd point<BR/><BR/>3) Massive accumulation of foreign reserves.<BR/><BR/>I remembered one piece of news that got flashed most often after the crisis -- the pont (3) above. The officials of various countries try to convince their citizens out of panic mode by stating that country XXX now have increasingly foreign reserve to support 3/4/5/6/7/8/9 months of import.<BR/><BR/>So contrary to your statement, I lived and saw currency-peg as a new thing for these countries after crisis, not before crisis. <BR/><BR/>And, their economic situations were booming as far as I lived it. Except they were running deficit that drawn down their foreign reserves that nobody was paying attention to. <BR/><BR/>That was what caused the crisis, once George Soros seized the opportunity and triggered it. <BR/><BR/>USA print money -- I mean to say USA government cannot just borrowed money Endlesslu to pay for oil through FED credit window, that they have to do start accumulate foreign reserve to pay for it. <BR/><BR/>Yes, dollar can still trade freely, but now you get back to Asian crisis mode -- remember why you need foreign currency to do your import/export thing?? <BR/><BR/>Contrary to your werid assumption on my position, I think deflation will come due to the massive debt credit problem. <BR/><BR/><I> < I am also guessing that you think inflation will be the order of the day and dollar will collapse. Maybe you need to get a better understanding of ...> </I><BR/><BR/>Don't over estimate your intelligence by making assumptions over other position.Shawnhttps://www.blogger.com/profile/08155630920582744324noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-15507723389735036472007-12-07T21:42:00.000+02:002007-12-07T21:42:00.000+02:00Anonymous said... WACC"If this company had all deb...Anonymous said... <BR/>WACC<BR/><BR/>"If this company had all debt, it would be worth less than with 50% debt/50% equity or 100% equity"<BR/><BR/>Wrong. Debt is accounted for after tax and is always cheaper ,even before tax, than equity.<BR/><BR/><BR/>Actually, this is a simplistic argument. The "WACC" on such a company would reflect a substantial risk premium to relfect the leveraged psoition which would likley make it worth less than a more "optimal" capital structure. <BR/><BR/>As for the "if anyone prints money they are done" comment, now that is juts wrong. If anyone prints money transparently their currency is done. But why print money when you can synthetically create it via dervatives: saves you money on the ink.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-92112366545443026722007-12-07T21:32:00.000+02:002007-12-07T21:32:00.000+02:00This was why there was a run in the Asian currency...<I><BR/>This was why there was a run in the Asian currency when people woke up to it, because fundamentally Thailand/Hong Kong/etc cannot print USD$, Australia$, Canada$ to satiisfy the import from those countries.<BR/><BR/>Now if Oil is priced in Euro and never in USD, I argued that USA would now be in a big hole to try to save foreign currency (in Euro, or whatever foreign currency to convert to Euro) to pay for oil. <BR/></I><BR/><BR/>Your comparison is not valid. Asian countries tried to peg their currency to a fixed exchange rate that was too high for their economic conditions. Their economic conditions were deteriorating, because the construction boom made by Japanese money ran its course. However, the countries tried to maintain their currency peg. To do that, they were bleeding dollars and nearly ran out of reserves. The market was not ready to exchange their dollars for pegged Thai baht, and so they had to readjust to what was reasonable.<BR/><BR/>In the current situation, US dollar is freely traded, Euro is freely traded and oil is freely traded. There is no government force trying to hold any of them to non-market value. So, the situation is not similar.<BR/><BR/>I realize where your confusion comes from. You think US government prints US dollar. I am also guessing that you think inflation will be the order of the day and dollar will collapse. Maybe you need to get a better understanding of our debt based monetary system. Nobody prints any money, and if any country does, it is finished.<BR/><BR/>BTW, I am from Asia too and been through the currency crisis.Greeniehttps://www.blogger.com/profile/16723475560144858107noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-42826781423192692802007-12-07T20:16:00.000+02:002007-12-07T20:16:00.000+02:00Dear CDS trader,Just because the CDS instrument or...Dear CDS trader,<BR/><BR/>Just because the CDS instrument originated from within the credit (debt) dept. doesn't mean it's a bond-type instrument.<BR/><BR/>As you very accurately put it, CDS are risk transfer instruments - but what type of risk? Certainly not yield curve risk. When we trade corporate CDS we trade creditworthiness risk = business risk = equity risk. <BR/><BR/>Just because there are few who trade the equity-corp. CDS correlation doesn't mean that it doesn't exist. If you have access to a B'berg run a COMP chart between any corp. credit index you like and S&P. (I will put one up ASAP).<BR/><BR/>If you are a dealer and you run a matched book, you can view YOUR risk as canceled out. This doesn't mean the OVERALL market is running flat. CDS is not a zero sum game. No insurance market can be.<BR/><BR/>I totally agree that $45 trillion in CDS notional does not mean that there is a "bet" of that size out there - you and I understand this. But the larger the notional the larger the systemic risk, no question.<BR/><BR/>Let me just ask this: what would happen to the CDS market if Morgan or any other major player said it has to take a $50 billion hit to their earnings - for whatever reason? <BR/><BR/>Would you then worry about counter-party risk? Would you pull up your book and look at every single position you have with Morgan - matched or not? What would that mean for the importance of notional, then?<BR/><BR/>All the best and thanks for commenting. It really, really helps.Hellasioushttps://www.blogger.com/profile/03564511281240682625noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-90730936420249393282007-12-07T19:22:00.000+02:002007-12-07T19:22:00.000+02:00I'd say all your numbers are pretty close, as yes ...I'd say all your numbers are pretty close, as yes sovereigns are a pretty small part of the CDS market (I'd say 1%).<BR/><BR/>BUT...I think the part "<I>It is thus possible to argue that these sums represent the amount of risk that has been shifted from the global cash equity market onto the CDS market</I>" is a leap to far...equating debt to equity is not that simple.<BR/><BR/>I think it's not right partly because the market size of those trading directly CDS versus equity is TINY relative to the size of each market (I'd be amazed if it accounted for more than 0.1% of equity volumes for example).<BR/><BR/>Yes, increased CDS trading may allow efficient transfer of risk, and allow MORE and CHEAPER issuance of debt for companies, allowing them to leverage, but you DEFINITELY cannot take the notional amount of CDS contracts (or CDS premium) and say that number represents anything. As I mentioned against one of your other CDS posts, notional values are misleading in that many of the trades will cancel out among counterparties.<BR/><BR/>Keep up the good work though!Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-15491439602658819892007-12-07T18:56:00.000+02:002007-12-07T18:56:00.000+02:00To David Pearson,Go to SIFMA's data:http://www.sif...To David Pearson,<BR/><BR/>Go to SIFMA's data:<BR/><BR/>http://www.sifma.org/research/<BR/>pdf/SIFMA_CDOIssuanceData2007.pdf<BR/><BR/>Issuance was heavy for synthetic CDOs in 2004-06 (total ~$190 billion, NOT including the unfunded tranches).<BR/><BR/>There was plenty of synthetic issuance even in 1Q07, but then it fell right off the cliff: -90%.<BR/><BR/>So...there's more where Adams Square came from.<BR/><BR/>RegardsHellasioushttps://www.blogger.com/profile/03564511281240682625noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-9993404321435216972007-12-07T17:46:00.000+02:002007-12-07T17:46:00.000+02:00Greenie, No, others and I are not argueing if Doll...Greenie, <BR/><BR/>< but what you are effectively saying is that oil is priced in dollar means US is strong. If oil get priced in euros, that would also mean strength of US diminished. Therefore it is harmful. ><BR/><BR/>No, others and I are not argueing if Dollar is going to be strong or not, because that may involve many other factors.<BR/><BR/>Let's revisit the most fundamental reason of Asia Currency Crisis 1997, as I lived through it daily.<BR/><BR/>Fundamentally, it was because many weak Asia countries had little foreign currency reserve for them to exchange for foreign goods. They ahd minimal Australia$, Canada$, Euro$, etc to deal with those daily import/export need in those countries. <BR/><BR/>This was why there was a run in the Asian currency when people woke up to it, because fundamentally Thailand/Hong Kong/etc cannot print USD$, Australia$, Canada$ to satiisfy the import from those countries.<BR/><BR/>Now if Oil is priced in Euro and never in USD, I argued that USA would now be in a big hole to try to save foreign currency (in Euro, or whatever foreign currency to convert to Euro) to pay for oil. <BR/><BR/>Now, how would that do to the currency strength, that will be a different topic. But USA CANNOT print Canada$, Australia$, Euro$. <BR/><BR/>The corner arguement of Mish, if I remember correctly, is that he think currency can be traded daily and freely with a click on the computer screen, and FOREX market is a daily Trillion dollar market.Shawnhttps://www.blogger.com/profile/08155630920582744324noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-67744194524764354662007-12-07T17:43:00.000+02:002007-12-07T17:43:00.000+02:00"Correlation does not mean 1:1...It means they var..."Correlation does not mean 1:1...It means they vary in similar fashion (this is a simplistic explanation, but...).<BR/><BR/>Think of two sinusoidal functions with different amplitudes running concurrently. One may go up +1 and the other only +0.5, but they both go up at the same time."<BR/><BR/>Not if the correlation coefficient is 0.<BR/><BR/>In the world of finance, correlation is a statistical measure of how two instruments move in relation to each other.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-37577044923061540852007-12-07T17:37:00.000+02:002007-12-07T17:37:00.000+02:00"The direct correlation is between credit risk and..."The direct correlation is between credit risk and equity risk, not between debt and equity in the capital structure of a corporation."<BR/><BR/>Even in bankruptcy the bond holders get paid first and most bankruptcies do not go the way of Enron or Worldcom.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-14127346456350502972007-12-07T17:35:00.000+02:002007-12-07T17:35:00.000+02:00WACC"If this company had all debt, it would be wor...WACC<BR/><BR/>"If this company had all debt, it would be worth less than with 50% debt/50% equity or 100% equity"<BR/><BR/>Wrong. Debt is accounted for after tax and is always cheaper ,even before tax, than equity.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-50779184382801441752007-12-07T17:26:00.000+02:002007-12-07T17:26:00.000+02:00Hellacious,Any thoughts on the Credit Suisse/Adams...Hellacious,<BR/><BR/>Any thoughts on the Credit Suisse/Adams Square synthetic CDO liquidation? It appears Credit Suisse had to pay out on the super senior swap, and I wonder how many more of these are out there?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-66883958467871820342007-12-07T14:58:00.000+02:002007-12-07T14:58:00.000+02:00Correlation does not mean 1:1...It means they vary...Correlation does not mean 1:1...It means they vary in similar fashion (this is a simplistic explanation, but...).<BR/><BR/>Think of two sinusoidal functions with different amplitudes running concurrently. One may go up +1 and the other only +0.5, but they both go up at the same time.<BR/><BR/>RegardsHellasioushttps://www.blogger.com/profile/03564511281240682625noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-3792591200898819742007-12-07T14:46:00.000+02:002007-12-07T14:46:00.000+02:00>I do not.The direct correlation is between credit...>I do not.<BR/><BR/>The direct correlation is between credit risk and equity risk, not between debt and equity in the capital structure of a corporation.<BR/><BR/><BR/>But credit risk and equity risk are different.<BR/><BR/>Equity risk is higher in almost all cases. Consider three high-risk cases:<BR/><BR/>1. equity holders lose 50%, debt holders lose nothing.<BR/><BR/>2. equity holders lose 100%, debt holder lose 50% in a debt restructuring.<BR/><BR/>3. company goes bankrupt, both equity and debt holders lose 100%.<BR/><BR/>Only in the third case are equity and debt risk correlated. <BR/><BR/>There's a whole industry that holds the riskiest corporate debt and simultaneously shorts the equity as a hedge, virtually hoping that the company hits the skids but doesn't go bust. It's called private investment in public equity (PIPEs).Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-63548215983840981492007-12-07T13:28:00.000+02:002007-12-07T13:28:00.000+02:00I think the poor suckers should sell their houses ...I think the poor suckers should sell their houses at once, almost at any price. Then they could pay off most of their mortgages, and most likely could serve the rest from their regular income. <BR/><BR/>Otherwise their position will only worse by the day. <BR/><BR/>Is there something in the new rules by Mr. Bush, which prevents this?Manehttps://www.blogger.com/profile/10464686842902277389noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-37578583724730937452007-12-07T11:13:00.000+02:002007-12-07T11:13:00.000+02:00To mane:I think it's not meant to help the average...To mane:<BR/><BR/>I think it's not meant to help the average borrower, but the average lender. Keeps the poor suckers in the house and chained to their mortgage forever, despite the fact they are already "upside down".<BR/><BR/>Instead they could walk away, rent at half the cost and stop losing money on a constant basis, as house prices continue weakening.<BR/><BR/>It's part of the hamster picture..<BR/><BR/>RegardsHellasioushttps://www.blogger.com/profile/03564511281240682625noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-16539399895004762262007-12-07T11:08:00.000+02:002007-12-07T11:08:00.000+02:00To Anon."Where you lose me is in making the leap t...To Anon.<BR/><BR/>"Where you lose me is in making the leap to equating corporate equity and debt."<BR/><BR/>I do not.<BR/><BR/>The direct correlation is between credit risk and equity risk, not between debt and equity in the capital structure of a corporation.<BR/><BR/>RegardsHellasioushttps://www.blogger.com/profile/03564511281240682625noreply@blogger.comtag:blogger.com,1999:blog-4102429195693595750.post-79258333888372646962007-12-07T10:56:00.000+02:002007-12-07T10:56:00.000+02:00The largest government debt issuers in the world (...<I>The largest government debt issuers in the world (US, UK, Germany, France, etc.) are themselves rated AAA and serve as risk-free benchmarks.</I><BR/><BR/>Maybe so, but if you think about the purchasing power of money, and given things like the fall in the dollar index and the rise in oil prices, I would imagine that a great many holders of dollar denominated debt now wish they had some sort of insurance against the fall in purchasing power they have suffered.Anonymousnoreply@blogger.com