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