Default Swap – CDS
Credit default swap is a particular
type of swap between two or more parties where they can transfer the credit risk
market bonds, mortgage-backed
securities, or corporate
debt. This contract also known as credit derivative contract. This type of credit derivative is
the most widely used and have a powerful force in world markets. JP Morgan first
introduced the credit default swap contract in 1997. By
using CDS contract, the buyer can reduce all their debt securities and
investments risk by switching it all or a portion of the risks to the CDS
seller or company in exchange for a periodic fee. The CDS buyer obtain credit
protection in where the CDS seller guarantees the credit
worthiness of the buyer debt securities. If the issuer defaults on
the payments, the CDS buyer
are entitled to the par value of the contract because of the credit protection. However,
the CDS buyer will lose some money if the debt issuer does not default and
makes all the payments up till maturity date. Eventhough the CDS buyer will
faces risk of losing some money if it’s all goes well, they will faces larger
risk as losing much greater proportion of their investment if the issuer
defaults and they didn’t have CDS.
bills, or T-bills, are a short-term debt instruments that have plenty types of
maturitiy. T-bills are issued by the US government at a discount
from par value. Usually time for maturity for T-bills are in term of one year
of less. T-bills can be considered as the world’s
safest debt because the investors will receives an IOU from the US government
which means they didn’t receive regular interest payments as with a coupon bond, but a T-Bill that include interest, which are reflected in the amount it pays when it matures.
In other words, T-bills are safe because it is backed by the full
faith and credit of the US government. Investor will receive the full face
value payment at the end of the maturity date. Although T-bills does not providing
interest payments such as other instruments, the difference between the discounted purchase price and the
full-face value equates to the interest rate earned by the investor. New
T-bills can be purchase at the government auctions. Investors who wants to
purchase the previously issued T-bills can purchase it in the secondary market.
Investors will have to go through a bidding process in order to purchase
paper is a short-term unsecured promissory notes issued by
companies. It can be used for financing of accounts
receivable, inventories and meeting short-term liabilities. Time to
maturity range for commercial usually up to 270 days, not longer than that.
Average maturity of commercial paper are between one and two months usually. It is issued at a discounted
face value and reflects prevailing market interest rates. Investors return are
calculated by the differences between that price and the face value at maturity
.Commercial paper is considered as very safe because only companies with high credit ratings
and credit-worthiness only will issue commercial paper. On the buyer sides,
commercial paper buyer mostly coming from other corporations, financial
institutions, wealthy individuals and money market funds. Small investors can
only invest in commercial paper indirectly through money market funds because
commercial paper are issued in denominations of $100,000 or more.
Negotiable Certificate Of Deposit (NCD)
A negotiable certificate of deposit
(NCD) is a bank guaranteed certificate of deposit with a minimum face value of
$100,000. This certificate are sold in a highly liquid secondary market, but it
cannot be cashed in before maturity. Same as commercial paper which have large
denominations, NCD are mostly bought by large institutional investors which use the certificate as a way
to invest in a low-risk, low-interest security. NCD was first introduced by
First National City Bank of New York, which is now Citibank in 1961. Bank can
raise funds that would be used for lending to customer by using this instrument.
Repurchase agreement (repo)
is a form of an agreement where government securities are borrowed in a short
term basis by a dealer. Government securities that have been sold by the dealer
today will be bought back by the dealer on the following day. This agreement
usually happen on an overnight basis. In other words, repurchase agreement is
when a party selling a security and agrees to buy it back in the future.
Reverse repurchase agreement happens when the party at the end of the transaction
purchase the security and agreeing to sell it in the future. Repurchase
agreement are used in the market for the purpose of raising short term capital.
Repurchase agreement is classified as a money market instrument. In this
market, buyers will be the lender while seller will be the borrower and the
collateral is the securities that being traded.
Long-term capital management
Long-term capital management
(LTCM) is a type of fund which is a large hedge fund. Salomon Brothers bond
trader, John Meriwether created the fund in 1993. The fund is led by Nobel
and renowned Wall Street
traders that nearly collapsed the global financial
system in 1998 because of high-risk arbitrage
trading strategies. Focused on bond trading, Long-term capital management started
with initial assets worth just over $1 billion. This fund trading strategy works
by making convergence trades. This trades takes advantage of arbitrage between
securities which are wrongly priced relative to each other. In order to make
money with the small spread in arbitrage opportunities, the fund had to
leverage itself highly.
leveraged buyout (LBO) is the acquisition of another company where the
significant amount of borrowed money are used to meet the cost of the
acquisition. The acquired assets of the company are usually used for the loans
as a collateral together with the acquiring company assets. Without committing
to a lot of capital, companies can make large acquisitions
by using the leverage buyout. Bond issued in buyout known as junk bonds because
of its high debt/equity ratio.
in Stock Market
sentiment or also called “investor sentiment” is very important for day traders
analysts who are using technical
indicators for them to calculate and gain benefits from the changes
in short term price which caused by attitude of the investors towards a
security. For contrarian traders, this stock market sentiment is also important
for them where they would act in opposite direction of the prevailing
sentiment. For example, contrarian would sell if everyone in the market is
purchasing. In stock market sentiment, trader takes advantage by making money
from the stocks that are overvalued or undervalued based on market sentiment.
Various types of indicators used by traders and investors to calculate stock
market sentiment in order to choose the best stocks to trade. Example of the
indicators are CBOE Volatility Index (VIX), 52 week High/Low Sentiment Ratio,
Bullish Percentage, 50-day moving average and 200-day moving average.
Stock Market Integration
Stock Market integration is an indicator that shows how
much different stock markets are related to each other. Stock market
integration happens when prices between different locations or related
stock follow same patterns for a long period of time. Stock
market is said to be integrated when a group of stock price often move
relatively to each other and the relation is very clear between different stocks
Efficiency in Bond Market
market can be considered as efficient because massive growth in communication
technology enables investors to access and react to market information faster.
Here is a few factors why bond market are efficient. First, bond pays lower
yields and are less volatile. Second, bond valuation is fairly straightforward
as the bondholders are promised with a fixed return and have specific maturity
dates. It makes the bond valuation generally easier and more precise. Last but
not least, bonds are not traded in centralized exchange or trading systems. So
in bond market, investors will only face minor challenges relating to issues of
transparency, subjectivity and liquidity.