CDS for the Common Man

Jul.30.08 | About: Societe Generale (SCGLY)

Why should institutional investors and hedge funds have all the fun in the current credit crisis? Now you too can join in. Societe Generale (OTCPK:SCGLY) is offering a new product that provides exposure to the credit default swaps [CDS] of speculative-grade companies. The new product is linked to the number of defaults in the iTraxx five-year Crossover Index, which is comprised of 50 European companies which Moody’s has forecast to remain below long-term average and market implied default rates.

As reported in an article at Structured Products, the product is designed to give investors an IRR up to 14.25%, provided of course that none of companies in the index suffers a credit event during 5 years of the product’s life. Events include bankruptcy, default, or restructuring. The notes can be purchased at 54-55% of face value and are redeemed 100% at maturity. They are also designed such that when each constituent experiences a credit event, 2% is subtracted from the total portfolio value. Estimates are that even if 17 of the 50 companies in the portfolio experience a credit event, the IRR would still be around 5.2%, above the 5 year European Interbank Offered Rate. Sounds good, but just remember that when major events do occur, certain assets will start to become more correlated very quickly.