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Equity v credit derivatives showdown: Difference between revisions
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You can set an ''arbitrary'' return — a hypothetical limit — and measure equity performance against ''that'' but this is not ''protection'' but ''speculation''. It is to buy or sell an {{eqprov|option}}: a true derivative. Equity swaps are in this sense genuinely derivatives, and no one hit up Robin Potts Q.C. for an opinion just to check they weren’t disguised insurance contracts. | You can set an ''arbitrary'' return — a hypothetical limit — and measure equity performance against ''that'' but this is not ''protection'' but ''speculation''. It is to buy or sell an {{eqprov|option}}: a true derivative. Equity swaps are in this sense genuinely derivatives, and no one hit up Robin Potts Q.C. for an opinion just to check they weren’t disguised insurance contracts. | ||
Because they have all those deterministic features — due principal, due income, due date — the debt obligations ''are'' intrinsically insurable. They are also far less prone to market fluctuation, and their volatility tends to zero as maturity approaches. There is a lot less call for speculation, therefore (not ''none'', to be clear, just a lot less, and it tends to be highly levered) and a lot more call for protection against those deterministic features. Credit events are not interested in market value fluctuations, therefore, but indicators that a Reference Obligation will not pay the whole amount it is scheduled to pay on the day it is scheduled to pay it. | Because they have all those deterministic features — due principal, due income, due date — the debt obligations ''are'' intrinsically insurable. They are also far less prone to market fluctuation, and their volatility tends to zero as maturity approaches. There is a lot less call for speculation, therefore (not ''none'', to be clear, just a lot less, and it tends to be highly levered) and a lot more call for protection against those deterministic features. Credit events are not interested in market value fluctuations, therefore, but indicators that a Reference Obligation really will not pay the whole amount it is scheduled to pay on the day it is scheduled to pay it. This is binary: indicators that it is merely less likely to be able to do that — ratings downgrades, Equity price triggers and so on — will not trigger a Credit Event. To be sure, they may influence “CDS spreads” — the premium one must pay to buy credit protection on the Reference Entity — and may lead to gains or losses in the mark-to-market value of a credit default swap, but these gains will reflect the present value of that spread differential against the original traded price, | ||