i’m confused on something, and i thought i knew a moderate amount about CDS before studying CFA. on page 319 of CFAI derivatives, it says " an example of this strategy is to buy a 5-year British American Tobacco bond at LIBOR plus 60 bps and short five-year CDS at 46, resulting in a negative-basis package of 14 bps"… and this does build off a few paragraphs above, but they aren’t very specific about the arb mechanics. anyway, shouldn’t we be buying BAT bond (so far so good) and BUYING CDS protection at 46… NOT selling (shorting) CDS… maybe it’s just a matter of terminology. maybe it’s tricky the way they talk about it (you’re not really buying or selling the swap anyway. i’ve never heard of someone buying a swap but if you own the bond and sell protection, then you get hit twice if the company goes backrupt… you want the bond and cds to offset the risks and you collect the small arb profit (maybe leverage it up)… anyway thanks in advance!!
Your right west, I think its with the wording. If you own the bond, you would definitely be buying the protection to hedge against default.
i thinis its related to basis trade, when you a bond with higher spread than CDS premium, you earn the higher spread and pay the relatively low spread for protection, it will make sense.
GMAC, if you pay for the protection, aren’t you BUYING the CDS?.. i understand the concept 100%, it’s just the wording that’s throwing me.
I had trouble with this wording myself, but I think when you buy the protection you are shorting the credit. So the one who is buying the protection is short and the one selling the protection is long.
buy protection = short RISK… think in risk terms and you will not go far wrong… basis = cds - cash cash generally > cds factoring in liquidity, etc…
yeah i think its bad wording. a neg basis trade is definitely long cash bond and you buy protection against it… they must mean short the risk not short the cds. generally if you are short a cds you are actually selling protection and collecting premium.
cjb001 Wrote: ------------------------------------------------------- > buy protection = short RISK… > > think in risk terms and you will not go far > wrong… > > basis = cds - cash > > cash generally > cds factoring in liquidity, > etc… good explanation… i just wish they’d said “short RISK”