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You might be able to buy a put on quoted bond at a reasonable price, but good luck with a privately negotiated term loan. | You might be able to buy a put on quoted bond at a reasonable price, but good luck with a privately negotiated term loan. | ||
Since, except in a [[tail event]] | Since, except in a [[tail event|disaster scenario]], debt repayment values are predictable in date and amount (unlike equities or commodities) as long as your borrower doesnʼt blow up you will eventually get your money back, it usually doesnʼt matter much — but when it ''does'' matter, it matters ''a lot''. You are hedging against a crash, not a basic variation in value.<ref>this is why, despite dealing with an instrument further down the capital structure [[equity derivatives]] are curiously '' less '' concerned with default than are [[credit derivatives]]. </ref> | ||
The [[credit default swap]] emerged | The [[credit default swap]] emerged as a neat way to manage that risk. To cover against losses on my private bilateral loan I could buy a credit derivative which would pay out if the borrower defaulted on its quoted debt (a public event I donʼt need to prove) and my counterparty must pay me a sum calculated on the estimated market price of a range of observable liquid instruments. A proxy for my loss: not perfect, but good enough | ||
====Trades are zero-sum games==== | ====Trades are zero-sum games==== | ||
Where a contract can be fully understood in monetary terms, expect the parties to do the utter bare minimum to discharge it. | Where a contract can be fully understood in monetary terms, expect the parties to do the utter bare minimum to discharge it. | ||