Louise Bowman. Euromoney. London:Jul 2007. p. 1
| http://proquest.umi.com.proxyau.wrlc.org/pqdweb?RQT=302&COPT=REJTPTRhNjEmSU5UPTAmVkVSPTI=&clientId=31806&cfc=1?did=1313080421&Fmt=3&clientId=31806&RQT=309&VName=PQD |
This article explains the movement towards long and short CDO strategy to try to buy and sell stock when there is a wide spread amongst the stock. Before reading the article I was a bit unclear as what they meant by shorting. After reading the article, I understand that when you short stock you are betting on the stock not doing well. I can understand why a company would want to do this but the risk it seems is unlimited.
The article goes on to say the strategy for the last four to five years has been using a long corporate credit strategy to correct a declining credit market. The market is facing this decline due to subprime. From my understanding subprime has to do with banks giving out loans to people who do not actually qualify for the best interest rates. Now the banks are asking for their money back and the people cannot pay the loans, which is causing the market to decline. The strategy to short the market seems like a good idea but I wonder if it is just a short-term goal? The article also mentions that the long/short term techniques is very challenging and I was wondering is it worth taking the risk?
It was interesting to find out that agencies tend to penalize short buckets in CDO structures because shorting is so costly. I can understand why because again the risk in unlimited. In addition, I did not know that Deutsche has already sold two hybrids long and short deals.
BNP Paribas the article explains has found ways to move around the systemic widening that usually results in a lost in terms of carry. If BNP Paribas continues to innovate this new strategy it might be possible to implement the strategy to hopefully correct the current market condition and eliminate or slow down subprime. In addition, the new long and short strategy the article goes on to say allows trading not just on credit but also maturity of the stock. That would be useful when buying or selling stock.
Furthermore, the article argues that the different maturities will allow people to take advantage of the spread. However, there is not an efficient way to price the CDOs using the standard base correlation, which could be a problem. Firms for now at least may or may not get the best price when using the new strategy until an efficient pricing standard is set in place.
I was surprised to find Goldman Sachs using this new strategy by selecting a long and short portfolio that is equal in size. What I did not know was that the long portfolio has a wider spread than a short portfolio, about twice as wide. The article mentions that the aim is to benefit from possible spread widening rather than actual default.
After reviewing this article, I feel the strategy is a big gamble now but I think it could be successful once all glitches are fixed. It seems like the strategy in theory is a great idea but at the same time, there is still a huge risk when trying to short to correct subprime.
No comments:
Post a Comment