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re: What is the purpose of swaps?
Posted on 1/18/13 at 1:16 pm to prplhze2000
Posted on 1/18/13 at 1:16 pm to prplhze2000
Swaps are bullshyte in most cases. Unless you are using a CDS to control potential risk as far as insolvency in a company you have an interest in or missed payments... see AIG 2008 also see Greek CDS which were technically in default for non-payment and most got NADA, nothing. SWAPs - complicated BS instrument created for decent purposes but built into confusing pieces of financial jargon usually serving the seller only
Posted on 1/18/13 at 1:28 pm to LSUAZ
It appears to me you are confusing credit default swaps with interest rate swaps.
Both types of swaps are useful as tools in decreasing two different types of risk, although the purchaser has to do due diligence on its counter party and must read the fine print carefully.
Both types of swaps are useful as tools in decreasing two different types of risk, although the purchaser has to do due diligence on its counter party and must read the fine print carefully.
Posted on 1/18/13 at 1:35 pm to LSUAZ
quote:
Swaps are bullshyte in most cases. Unless you are using a CDS to control potential risk as far as insolvency in a company you have an interest in or missed payments... see AIG 2008 also see Greek CDS which were technically in default for non-payment and most got NADA, nothing. SWAPs - complicated BS instrument created for decent purposes but built into confusing pieces of financial jargon usually serving the seller only
So wait, you're saying interest rate swaps are bullshite and CDS is a good hedge? That is, and I really don't like saying this, just completely fricking wrong. When a credit event actually takes place and you go into the auction process for recovery on CDS, that is a very complicated process. Interest rate swaps are the most simple derivative in the market, and there is no such thing as a "seller" of interest rate swaps. It's just a contract between two people, one side pays a fixed rate and one side pays a floating rate.
Swaps, as Russian has tried to say, are nothing but tools to either hedge interest rate risk or speculate on interest rate risk. Banks primarily enter in the pay-fixed side as most of their assets are loans that they receive fixed payments on. Their liabilities are floating rate instruments so they cut their interest rate risk and can plan cash flows.
Swaps are mainly used in portfolios to manage duration, you can lower duration by taking the pay-fixed side or increase duration by taking the receive-fixed side. Since it's a contract and not a security, you don't have transaction costs so it's a really cost effective way to manage duration. Counterparty risk is another issue. You can also do swaps on almost every rate so you can eliminate some basis risk with trades as well.
My favorite instrument in the market is actually an option on swaps, called swaptions. Probably a different topic for a different day but those instruments are awesome ways to trade volatiliity, convexity, and even yield for a portfolio
ETA: I'm guessing you're referring to CDS as swaps. Apologies for the rudeness but please designate. There is a laundry list of different types of swaps.
This post was edited on 1/18/13 at 1:39 pm
Posted on 1/18/13 at 1:36 pm to LSUAZ
quote:
see AIG 2008
Ironically, AIG's whole problem was that they didn't buy the swaps they should have.
Their FP division had a great business going selling CDS protection to people, but they neglected to hedge their business against risk from an increase in volatility.
They probably could have weathered the storm without a bailout if it weren't for all the margin calls on the CDS contracts they wrote to various buyers. If they would have bought some insurance in the form of variance swaps, they could have been okay.
But they didn't know what they were doing, because they were an insurance company (under siege from the Eliot Spitzers of the world, by the way) trying to branch out into sophisticated financial products. From what I hear, they got a bunch of hired guns to run that part of the business, without having any idea how to implement a competent risk management program. The hired guns had free rein to take risks without following quality control, which is fine for an individual, but gets dangerous for the whole corporation.
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