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Credit Default Swap Insurance Prices Soar on Financial Crisis
The price of credit default swap insurance has been rising substantially, in a large part due to the financial crisis America and the rest of the world is experiencing. A credit default swap is one form of financial derivative that will act as insurance on bonds. For a specified price, the swap seller will guarantee that the product is credit worthy, acting as insurance for the bonds. The risks involved in the default of the product is transferred from the buyer back to the seller in a credit default swap. Credit default swaps can result in large liabilities for the seller of the swap, if the underlying asset no longer has value. Because of this, credit default swap insurance can be purchased to protect the seller against these liabilities. The financial crisis and economic downturn experienced globally has made this insurance far most costly.
The financial crisis has investors losing confidence in almost all the markets. Many credit default swaps are written on investment banks, including the troubled Bear Stearns, and these are the sectors that are failing and needed bailout help from the Federal Government. This means that the price of credit default swap insurance has gone up by a large amount. Credit default swap pricing has also gone up significantly, partly due to the higher insurance costs. When the risks of credit swap defaults increase, so do the costs of the insurance against these defaults. Investment banks have seen increased credit default swaps and higher costs associated with these. This has been caused because of concern over balance sheets which are damaged because of the leveraged buyout market and the sub prime mortgage crisis.
In January of this year, a credit default swap which offered ten million dollars worth of credit protection on a debt through Bear Stearns for a five year period would cost you around thirty thousand dollars a year. If you tried to get the same insurance right now in the middle of the financial crisis, you would pay four to five times this amount, at a minimum and it could be more. If Bear Stearns folds, the insurance holder would get a ten million dollar payment. The credit default swap insurance rates are soaring for every business and investment bank. Credit default swaps are purchased by investors to help them hedge against the risks. These swaps are also used by investors to create big bets on their side if an unforeseen event occurs.
Credit default swap pricing has gone up, just like credit default swap insurance prices. The financial and economical crisis that is playing out across the globe right now significantly increases the risks that a company or investment bank will fall. We have watched a number of old firms fall or need assistance from the government to prevent a failure. Everyone was shocked when Lehman Brothers folded, and they could just be the tip of the iceberg. The credit default swap insurance coverage for this investment bank alone cost the insurers millions of dollars. This has made credit default swap insurers very leery, and caused rates for this type of insurance to skyrocket. The demand for the credit insurance is so high, especially in these tough economic times, that banks have a hard time keeping up with it. This has been a problem for a few years now, and the Federal Reserve Bank of New York made a demand a few years ago that the banks clean up the backlog present of trades which were not confirmed or settled.
The information supplied in this article is not to be considered as medical advice and is for educational purposes only.
|Bond Investment6 Feb 2009