Smarty_Pants

Exchange-Traded Derivatives: Why Stop at CDS?

gramps2:

Good points.

One positive side to making derivatives exchange traded is that the exchange usually backs the contract performance. If you trade a futures contract (an exchange traded derivative) your actual counterparty is the exchange (read the fine print).

You don't have any idea who took the other side of your trade, you only see a bid/ask. The exchange is legally a counterparty to both sides. If you default on payment, the exchange is going to be the one looking to collect, not the other party.

That doesn't fix all the problems, but it does make things more transparent and less likely to blow up in your face. It's always possible to do stupid things and lose all your money as a result. (Think Hunt brothers.) That can't be stopped, but it can be made more unlikely.

Still, I like your idea of eliminating banks altogether. It has some merit.

Credit Default Swaps, Part One: Origins and Implementations

Research:

The extra yield for corporates would be required to pay for the "insurance" needed to make them equivalent risks to treasuries.

As the article notes, the insurers can't afford to tie up sufficient capital to cover the worst case at the current premiums.

The premium paid would need to be increase to the point where the cost of setting aside sufficient capital is profitable. It's likely that doing so would make the cost of insuring the bond exceed the interest paid therefore rendering the 'insurance' beside the point. Why buy an asset that pays $100/month when it costs $200/month to 'insure' it?

Sounds like this is a product that isn't finiancially feasible strictly by the numbers unless the credit rating of the issuing entity is top notch and the true chance of default is very small.

As LEH was percieved to be a very small failure risk and later proved that perception wrong. It sorta sounds like these instruments aren't economically sound for all parties.

Hey, at least there's only $55 Trillion of the things out there.

Yikes!