kdo

Berkshire Bond Yields vs. CDS Rates

Hate to point out to you dlaw, but my sample arbitrage requires nothing to happen and is a risk free arbitrage. Try reading it again. Yours requires a downgrade and increase in BRK yields which has not happened yet and is thus a guess. Mine is a true arbitrage, yours is a bet and thus not arbitrage. Someone making your bet would be much better off simply shorting the bonds, because CDS are so expensive.

btw - let's explore CDS is a "larger market". Let's imagine for a moment, that if I bought a derivative of a bond from you. We'll call it a derivative since it won't be the actual bond itself, even though it will function 100% the same as the underlying bond itself. Now, I have a notional exposure of the total position and so do you. Bonds are worth $1 million, notional exposure is $2 million, since we both have a position. Then I trade it to someone else, perhaps even you at a different rate to adjust for yield changes. Notional exposure is now $4 million over the $1 million bond equivalent and now we just have a small spread yield payment in between us. On it goes every time it's traded including anyone else who comes into the trades. It's still just a $1 milion bond. The notional exposure means more about trading activity than it does about real exposure. How big do you think the bond market or stock market would be for that matter if notional exposure multiplied by two every time it was traded and was simply added to all other "notional" value of every trade made? Bigger than GDP? So much bigger than GDP it would be ridiculous to think it has any meaning to derive from the number?

04:25 PM dlaw wrote:

> "Real, economical, pure free money." - incredible. Something about
> Warren Buffett causes people to live in a complete fantasy world.
>
>
> But the author does show exactly why the CDS are so expensive: CDS
> are not only a default aritrage, they are also a spread arbitrage.
> While there are credit spread swaps (which would be the more-precise
> way to play a spread arbitrage) apparently CDS are the larger market.
>
>
> If BRK bonds are trading at a premium to the AAA market, then CDS
> are a perfect way to play the arbitrage between BRK bonds and the
> AAA market. Since the derivatives losses seem a no-brainer to at
> least move BRK bonds down 133 bp - as the author notes - there is
> a nice, built-in cushion to the downgrade/default play.
>
> So thanks to the author. Sometimes you can learn what's right by
> reading what's wrong.