Monday, July 16, 2007

Credit Default Swaps

The Pinnacle Notes has a "credit event". If any of 5 entities default, the investor has the chance to lose up to 40% of the invested amount.

What is the likelihood of this happening? I checked the internet for "credit defaults".

I found a link to "credit default swaps" or CDS. It appears to me that the Pinnacle Notes have CDS built into the product.

I find it quite complex to understand the CDS, especially to calculate the chance of a "credit event" occuring.

You should read the section on "Criticism". It quotes Warren Buffet.

Lesson: If you are not able to understand a product, do not invest in it. You do not know if you are getting a fair deal.
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3 comments:

Anonymous said...

The swap is to insure its credit exposure. Therefore in the event of a default, the loss is mitigated. It is like buying future or option to hedge against a downside risk. The fund managers use plenty of these derivatives. If you look at Income's funds quite a substantial amount is spent annually on theses derivatives.
Therefore it is no surprise that synthetic fixed income like Minibond uses too.

July 16, 2007 10:51 PM
Tan Kin Lian said...

I am not familiar with the MiniBond.

But, I know that some structured products invest in credit default swaps to enhance their yields. They sell the swaps (to take the risk, i.e. like selling insurance). In the event of a credit event, the sellers of the swap (ie the investors in the structured products) can suffer a big loss.

This is why the investors in the structured products are warned that you may lose part or all of your investments.

Is the risk small? I do not know.

Lesson: Do not invest in any product where the risks are not clear!



They are taking a big risk

July 17, 2007 7:24 AM
Anonymous said...

I think it is to understand whether you'd like to bear the risk when invested.

July 23, 2007 9:48 PM

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