bail-in bonds

  • 11 Feb 2013 at 3:01 PM

CDS Contracts Not Ready For The Ways We Go Bankrupt Now

CDS, what is wrong with you? Here is how CDS should work:

  • There are bonds.
  • You buy CDS that is supposed to pay off if something goes wrong with the bonds.
  • Something goes wrong with the bonds, insofar as they default.
  • Like so:

  • So you scoop up a Defaulted Bond, hand it to the CDS seller, and he hands you back the face amount of the bond.
  • He’s stuck with the Defaulted Bond, and effectively loses the difference between the face amount of the bond and the value of the Defaulted Bond.

In the modern world here is what often happens:

  • There are bonds.
  • You buy CDS that is supposed to pay off if something goes wrong with the bonds.
  • Something goes wrong with the bonds, insofar as they poof into some weird garbage-y thing or assortment of garbage-y things.
  • Like so:

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