Capital Structure Trades - Vol.6 :Reading 63, page 360 its, believe, anybody, company

himanshumh

I think this is a mistake on CFA book but I need to confirm. On the first paragraph under “Capital Structure Trades”, the book menioned to sell CDS on Ford Motor Credit and Buy CDS of the holding company. I believe this is incorrect as they mentioned that Ford Motor Company was going to deteriate but its subsidary was in better shape. Therefore, we should buy cds on Ford Motor company and sell CDS on its subsidary. Does anybody agree with me? Or am i going nutso?

bolligerallstar

I agree, would have to look at the text again, if a holding company is going to fail, buy the CDS and sell the CDS on the sub if its in good shape.
What I understand a cap structure trade to be is that you benefit off the spread btw the buy/sell.
Sell CDS 200bps
Buy CDS 100bps
**Collect 100bps spread and hope the spread increases i.e. an event occurs or keep the premium

draz

Thx bud. I was going nuts as this wasn’t pointed out at the errata

Spongebob

Summary:
* Ford Motor Company is going to deteriorate – BEARISH
* Ford Moter Credit is ok – BULLISH
* When you’re bearish you want to own a CDS, and when you’re bullish you sell.
Sell a CDS on Ford Motor Credit, buy a CDS on Ford Motor Company.

Gypsy

CDS is like taking insurance…Company is deteriorating, so you protect it by buying insurance - so you buy a CDS for it…

luckygiftvn

This last reading on derivatives is driving me nuts.
According to paragraph 1 on page 354 V6, under “Evolution of the Credit Derivatives Market” we have got the following;
Protection buyer = short the credit (CDS) = pay premium
Protection Seller = long the credit = receive premium
(which is also consistent with the example on Basis Trades on page 359)
So on page 360, under the Capital structure trades;
If we do what you suggest above;
- Buy Ford Motor CDS, thus we are a Protection seller and we receive a 400bps premium.
- Sell the Subsdiary’s CDS, thus we are Protection Buyer and pay a 525 premium.
In that case we would be losing the spread if i am not wrong; receive 400 & pay 525
IF we do what the book says;
- Sell Ford Motor CDS, thus we are a protection buyer and we pay a 400bps premium.
- Buy the Subsidiary’s CDS, thus we are protection seller and we receive a 525bps premium.
Then we would be earning the spread.
What is bugging me here is how the spread widens. In either case if the subsidiary is in better shape (which makes sense because we are selling protection to sb we know is in better shape), then the premium shouldn’t narrow? Ford Motor CDS premium would most likely increase above 400bps and the Subsidiary’s premium should, in the best of the cases decrease or stay the same right? how does the spread widen????
Can sb comment on this please.
Thx