Introduction to credit default swaps. Created by Sal Khan.
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Doesn't 1B dollars of assets set aside for 1T dollars of potential payout essentially mean that the probability of the company going bust is 0.001? So essentially 1T x 0.001 = 1B dollars? You could question the calculation of the probability though.
The -85% is reflected in their accounts generating disconfidence in the other contracts, so the Fed had to inject a large amount of billions to avoid contagion. Degrading even more the rating and losing capital value.
AIG have a risk coverage fund, but not the total amount of the transaction, 10/15% insured. But nobody expected the financial banks to put so much leverage into subprime mortgages, so in many cases the investment of 1 billion, meant losing 800-900 of the total. So the insurer had to face a hole of -85% of its balance to return to the pension fund.
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Somebody I think already asked this too.
But if I'm the CDS seller and I will insure company A for 1% return annually, why not just have the CDS seller buy the bonds themselves then? Either way they company A goes bankrupt they have to pay the full bond price so I don't see why they wouldn't just buy the bond themselves such that they ge touch higher returns
To buy these bonds I have to use my own equity, but selling CDS contracts doesn't require me to hold the reference product. When I sell CDS I can hold contracts worth more then my current equity/ capital. AIG would have $20 bn. in equity, but could hold $140 bn. worth of CDS contracts.
Why would AIG support the risk for only 1%/year when they could have bought A's bounds and get 10%/year ? Is it juste because AIG want's to keep its asset and can't just lock the 1B?
If the 10% fee payed by B correspond to a 10% default probability, by asking for a 1% premium they are statistically losing money by covering the risk, while the fund makes 90% of the profit with no risk at all ...
Makes no sense to me, but again, I only have a PhD and a good understanding of statistics and probability ...
I'm just now learning all of this stuff so I could be wrong, but I think you're right in thinking that AIG doesn't want to buy A's bonds because that would indeed lock up 1B of their assets. If AIG doesn't have to designate any of their assets towards buying the bonds from various corporations, then AIG could indefinitely ensure investment firms for total amounts that greatly exceed their total assets.
Also I don't think that the 10% fee paid by corporation B corresponds to their default probability, otherwise you'd be right in saying that statistically AIG would lose money. The only indication of a corporations default probability that we have is whatever rating is given to them by these private rating agencies.
Why are you assuming the government would be more objective with its ratings? The government's main business is being bought out by special interests, subsidizing, bailing out, picking winners and losers.
Why would AIG act as insurers when they can act as debt/loab brokers all they have to do is accept less interest rate maybe 25bp/50bp. Yeah they get less interest but they don't have to pay the pension funds back if other corporations defaulted. It's no risk for them while they're getting constant flow of money as long as the corporations are paying interest to the pension funds.
Question: I will use your examples to hopefully explain the question properly...
Could a fund (CA pension fund) buy multiple insurance policies or CDS with different insurance corporations? Meaning if they loan $1B to Business A and insure that with a CDS of 1% of the 10% premium they are earning from Business A. Then do exactly the same thing with another insurance company (thus losing 2% of their 10% premium) doesn't this practically double the amount they have loaned should Business A default? As they will receive the $1B from insurance A, then another $1B from insurance B?
Hope this question makes sense! Thanks!
Its legal since The risk from the bb bond is transfered from the pension fund to the AAA Bank, and the only risk the pension fund is taking is liquidity risk of the AAA Bank, so the risk that AAA Bank cant pay you the insurance. But again they are rated as AAA secure, so the liquidity risk should be small.
Dodd-Frank Act provides guidance on security-based swaps rules, affecting credit default swaps under Title VII. Security-based swaps are defined as "securities" and now fall under the jurisdiction of federal laws, Securities Act of 1933 for ex.
The Commission provided temporary relief from provisions of U.S. laws that allow the voiding of these contracts. They still can insure more then they have but with respect on the Basel 3 leverage ratios and liquidity standards.
Who paid Moody's to give such a Rating!!!!????? Ahhh Haaaa. Imagine AIG contacts Moody's.... We need you to rate our default risks!!! Now if Moody's give AIG a crappy rating, what are the chnaces that big money AIG calls upon them again?? Complete conflict of interest right there.
nailed it. that's how business works. you rub my dick....I'll rub yours. we need third party companies to be established that can't be bribed or bought and absolutely without a doubt model their business on integrity and values, not just speak of it.
So American libertarians, conservatives, Ron Paul types; after watching this video, to prevent this scam from happening again we need less government regulation?
Kind of like the solution to a community with crime problems is fewer policeman to enforce the laws?
I think what Follow Media is saying is to have both the bail out AND increased regulation (to prevent future need for another bail out) and so have both short and long term benefits while you are advocating to do neither. There is greed on both buyer and seller side, which negates your argument of intelligent investors and careful banks. You are right that standards have not been kept, but standards will always take second priority to short term profits if there is no strict oversight from the government aka regulation.
if the marketplace is allowed to work (the institutions allowed to fail) those who are customers of them (pensions, govts.) will be more intelligent about what they are buying and, eventually, the marketplace would hold those institutions to such a high standard that the institution would not be able to sell its products without so much evidence guaranteeing the investment that it would be a stronger investment than if the U.S. taxpayer (government) was constantly bailing them out after an event...if the govt. continues to bail them out you WILL continue to "fall into the hole" as you call it because of moral hazard...you have to realize that the last few generations of institutional investors are much less intelligent about what they are investing in than, say, people of 4 and 5 generations ago, and that is because people who lived through the depression never forgot the lesson of loss after undertaking the risk associated with the stock market...lower interest rates necessitated by ridiculous debt enticed investors to chase yield and that means risk...they had not experienced great loss like the depression era people and, more to the point, were not held to a high enough standard by those who own the pension funds and the taxpayers who elect the officials who made the decision to buy those risky products...yours is a short term answer with long-term repercussion while mine is a short term sacrifice for a long-term benefit
people don't seem to get that the american taxpayer or pensioner pays whether or not the bailout happens. they just suffer much longer without the bailout. apparently some are willing to let themselves and their neighbors and children suffer more just to see the bad guy go down, instead of get out of the hole ASAP and try not to fall into the next hole in the future. some weird cut-off-own-nose-to-spite-your-face logic going on here. also very strange to see comments about evil corporations being mentioned in the same breath as complaints about overregulation. it's quite obvious to a non US citizen that the problem is lack of regulation.
Jesus - you ramble on and on. This video could have been two minutes long but unfortunately you like to, oh I dunno, let's just say, here yourself speak, right? Yep. Hear yourself speak. If you cut out all that stuff, like just cut it out, and let's say, I dunno, stick to the basics and be clear and concise, you could, let's say, cut this video down to like, how about like two minutes, ok? Like two minutes. Fuuuuuck.
An allowance for bad debt is a valuation account used to estimate the portion of a bank's loan portfolio that may ultimately be uncollectible. Lenders use the allowance for doubtful accounts method because the nominal value of a bank's total loan balance is not the actual balance that is ultimately collected, since a portion of the loans may default.
Good educational program for lay man. This was a scam, no matter how you put it. AIG could not cover the insurance. They fucked many citizens, and this will happen in 20 years again. If people continue to purchase what they can not afford. Tell me one thing. did AIG get bailed out? Yes they did, then they paid themselves alot of cash to the cocksucking CEO and staff. Lets see what happens next. Enjoy your day.
Like any financial institution,if every loan (or insurance) pays it's great. If a financial calamity occurs and enough big debtors go bust simultaneously then it is insolvent. So unless it has enough cash to cover EVERY single CDS, and it doesn't, it's technically insolvent.
You make it sound like the credit agencies couldn't do a good job. It is true they blew the MBS and CDO markets. However, they were quite accurate on ratings for everything else. Essentially, they had issues rating Mortgages and their derivatives mostly, due to the reasons you spoke about in your housing bubble section.
"only the government would be objective enough" wtf, since when was the government objective, once representatives retire from politics where do they go? the corporate sector where they are rewarded for past compliance to private interest groups
@treysparker What's deaf or blind got to do with anything? Stow that, please. What he says is not "absolutely against the free market." It's against absolute blind faith that the free market always doing what's best. We want accurate ratings. Can the gov't do that? Probably as well as Moody's. Can the gov't be corrupted? Certainly.
But surely you see that being paid for ratings has the potential for abuse and at least the appearance of impropriety?
@PhilipNolan49 What personal political beliefs is he showing? Where does he indicate he disdains the free market, or believes the government is the perfect solution to every problem, or profits are wrong? Where is he moralizing? Not in this video. It sounds like your political beliefs are showing. The government is not to be trusted implicitly, but neither is the "free" market.
Good job of explaining credit default swaps. That is very much appreciated. But it would be nice if you didn't allow your personal political beliefs to get in the way.
It is clear you disdain the free market, believe the government is the perfect solution to every problem, and think profits are wrong.
It is your video and you clearly have every right to express your opinions. I am just saying that it would be more effective to explain the concept without the moralizing.
how do you hedge between stock and CDS by going long on both? What does that mean. E.g. Paulson recently bought $1B HPQ shares, but the stock went down, so he could've also played relative value long CDS - what does this mean? Thank you!
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