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Bloodsport on Wall Street

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Bloodsport on Wall Street

Hedge Funds Make Mayhem for Profit

Bloomberg Businessweek ,

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Hedge funds are increasingly using credit default swaps to game the financial system.

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Editorial Rating

8

Qualities

  • Analytical
  • Eye Opening
  • Concrete Examples

Recommendation

Credit default swaps (CDS), those bad actors from the 2008 financial crisis, are back. In this intrepid dispatch, Bloomberg Businessweek’s Claire Boston and Davide Scigliuzzo report that a few financial wizards are gaming CDS contracts. CDS play a straightforward role in letting a lender hedge against default risk, but in an unexpected twist, inventive traders are buying contracts to protect against default risk and then rewarding the borrower in question for defaulting. Market watchers and investors will find this an eye-opening read.

Summary

Credit default swaps (CDS) act like insurance policies; these derivatives let lenders protect themselves when borrowers can’t pay. CDS instruments deliver a win to a counterparty on one side of a contract if the borrower defaults, or to the counterparty on the other side if the borrower doesn’t default. From that simple premise, savvy traders have seized upon a nuance in the CDS market: A market participant need not own the debt of the company in question to buy protection against its failure to pay. And there’s not much stopping a hard-nosed trader from buying a CDS contract...

About the Authors

Claire Boston covers credit markets for Bloomberg, where Davide Scigliuzzo is a corporate finance reporter.

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