Equity v credit derivatives showdown: Difference between revisions

Equity v credit derivatives showdown (view source)

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 Because there are literally no expectations about what they will pay — not even a redemption date — equities pogo around, depending on the issuer’s quarterly performance, paranoia, market sentiment, geopolitical currents, internet memes, Reddit, whatever Elon tweets about and whatever the madness of collected action believes to be germane to the business of, well, business.  Equities could quite easily be up 200% or down 70% over a six-month period with neither making a tremendous statement as to the basic creditworthiness of the Issuer.
-so oddly, while you would expect equities to be about corporate default and credit derivatives to be about relative performance in the absence of default, it is the other way around. Credit derivatives, like Bonds, tend to have a fixed term and while you can mutually terminate them at market price, there is no right to in the absence of a catastrophic failure. Equities tend to be exercisable at any time,
+so oddly, while you would expect equities to be about corporate default and credit derivatives to be about relative performance in the absence of default, it is the other way around. Credit derivatives, like Bonds, tend to have a fixed term and while you can mutually terminate them at market price, there is no right to in the absence of a catastrophic failure. Equities tend to be exercisable at any time.
+==Vibe==
+Bear in mind the characteristic distinctions between equity and debt. Equities have no term, no stated repayment, no defined yield or return. They represent what would be left were all such instruments satisfied in full. By contrast senior debt obligations have all those features: a defined repayment amount, due date, and deterministic yield (“deterministic” in that it can be observed objectively by reference to something other than the performance or business condition of the issuer).
+It kind of follows that you can’t “protect” or “insure” the return of common equity. Protection is measured as loss against an expected return: equities do not have one. Equities have just a prevailing market value, which can pogo around unpredictably — literally unpredictable — propelled by macroeconomic and geopolitical conditions and, always, the madness of crowds.
+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.