Credit value adjustment: Difference between revisions

There is a neat logic to this — if I consider [[out-of-the-money]] exposures to be my term [[indebtedness]], then if my prospects have worsened, I would be able to buy this back at a discount to its face value for exactly the same reason, so why shouldn’t I mark it down?

So the [[investment bank]]s did, and in size. They called these “[[debt value adjustment]]s”, and while it was a thing, it didn’t fare so well and these days there aren’t as many Investopedia articles about it. But, around 2011, it was the talk of the smoky salons where credit traders would gather to complain to each other about the prevailing squeeze on their credit. Strangely, as this alleviated, they grew less enthusiastic about having to pay to hedge away the cost of their own improving fortunes with [[credit derivatives]] as, oddly it began to seem a bit silly.

So you would not be alone if you felt something tugging at your gut saying this seems a bit [[snake oil]]-y. Because it is. If you think your ''own'' credit deterioration is an excuse to book a ''profit'', you should get your coat. Just because, as you lurch towards [[insolvency]], the value ''to your creditors'' of your [[liabilities]] tends to zero, it doesn’t mean their cost ''to you'' tends to zero. You are still fully liable for that [[indebtedness]], come what may. That you should have collapsed into ignominious torpor of [[bankruptcy]] before being able to honour it does not mean your obligation doesn’t exist, and it certainly shouldn’t go towards your [[pnl]].

WITH WHAT, DEAR LIZA? The theory is ''your business is swan-diving into the side of a hill''. If you had free [[cash]] available to buy out all your debts, ''said hill would not be filling up your entire field of vision''. You don’t have any goddamn money to buy your debts back. That is your ''exact'' problem.

“But I could borrow so —” and here, dear reader, follows a pause. “Oh, hang on. I think I see the problem here.”

Right. You don’t have any money, so you would have to borrow it. Even if you could find someone prepared to lend to a soon-to-be-bankrupt company (look, it does happen),  it would lend to you at your current state of indebtedness. So you would be trading your apparently cheap [[indebtedness]] for ''more expensive [[indebtedness]]''.