Explain "buying debt"

[livinitup0]

[ QUOTE ]
liv, why don't you just read the article [img]/images/graemlins/wink.gif[/img]

[/ QUOTE ]

I spend too much time reading collection articles as it is [img]/images/graemlins/smile.gif[/img] I also dont have access to 2p2 at work.

I know what the OP is talking about now. Definately big profit....but you need a big foot in the door and a hell of a lot of startup cash, not every joe with money can do this.

[Hellrazor]

[ QUOTE ]


[/ QUOTE ] are there options on corporate debt? thats a good way to bet on bankruptcy i think if it were feasible, buy OTM puts on the debt if you think there is a larger than priced in chance the corporation will file chapter 11.

[/ QUOTE ]

Yes. They're called credit default swaps. All the big investment banks make a market in them. It's a non-transparent, very lightly regulated market making it nearly impossible to know who owns them, who has written them, or whether or not the writer of the option will be willing and able to perform in the event of a credit default. They trade over the counter and don't go through an option clearing house, so it's really the wild west.

In the benign credit environment of the recent past, writing credit default swaps has been like free money. Hedge funds have approached them like insurance, belieiving that if they write CDS on a large number of creditors, the premia from the issuers who don't default will cover their obligations against the few that do after recovery. They certainly have super sophisticated models to assess value at risk, but it's really a grand untested experiment. My feeling is that adverse events in insurance happen more or less randomly. For example, if a neighbors house 3 blocks aways accidently catches on fire, there's no reason to think my house will accidently catch fire. But when an economy turns down, financial distress begets financial distress. The primary element of randomness that makes insurance work is violated. It's going to be interesting to see how it plays out in the next downturn.

CDS do add to volatilty. Delphi is a good example. Before Delphi defaulted a couple of years ago, the notional value of the CDS written on Delphi debt far exceeded the par value of the Delphi debt outstanding. Perversely, when Delphi finally filed for bankrtupty, the value of Delphi's bonds actually spiked. Did they spike because the debt had suddenly become more valuable upon the bankruptcy filing? No, they spiked because many of the writers of the credit default swaps bought the bonds in the open market at a discount to par rather than risk having the credit default swaps assigned to them at par.

[/ QUOTE ]

While you're correct that one way to bet on banruptcy is to buy a CDS, you're way off on the spike in delphi prices being attributed to sellers of CDS buying up bonds at a discount. Delphi was mostly "cash settled" where bonds/loans were not delivered to be paid back at par but rather an auction was held to determine the accepted recovery rate and coverage was paid back based upon that. (I am sure some were physically settled still but not anywhere near the gross notional amount of CDS outstanding)

Also, it's important to note that there are many "tear-ups" when there is a Credit Event so that most dealers (and some client side as well) net down position pretty well and only a small fraction of outstanding CDS coverage is actually settled when a credit event occurs.

Also there are practically zero private investors who have CDS. Lastly while CDS are still mainly unregulated - the Fed and FSA have taken a big interest and require regluar reporting on CDS from the major broker dealers who in turn have asked clients to comply with various iniatives to add control to the market. As for no clearing house - check with DTC on that- the DTCC wharehouse will hold almost all (live) CDS trades (more than half of all current trading is confirmed through there and it is a Fed and FSA mandate to get the % clearing through DTCC (a part of DTC) to be at a very high rate.

[DrewDevil]

didn't read the rest of the thread, but "buying debt" is just a fancy way of saying "buying bonds"

[NajdorfDefense]

[ QUOTE ]
didn't read the rest of the thread, but "buying debt" is just a fancy way of saying "buying bonds"

[/ QUOTE ]

Um. Not anymore. You can buy bank debt and senior loans directly now from many large banks. This is dramatically different from buying bonds, but OP was confuzzed.