Credit Default Swap

1.

Credit Default Swap is a contract that provides insurance against the risk of default of a particular company. There are two parties involved in this insurance: a buyer who makes periodic payment to the other party to seek for protection when the company defaults, and a seller who agrees to pay for the company’s debt when it defaults.

2.

The market for CDS exists mainly because financial institutions such as banks can use CDS to hedge for their lending risks. For example, in the case of CBI, its credit exposure with respect to CEU would be too large if it accept the new request for loan, but meanwhile, CBI doesn’t want to destroy their relationship. Under such circumstance, by purchasing CDS from another bank, CBI will have a guaranteed payment if CEU defaults on its debt, but avoid violating internal credit limits.

The buyers of CDS are usually individuals or companies that are exposed to a large credit risk when they do lending activities. The sellers of CDS are usually financial institutions with high credit rating. Once the reference entity goes bankruptcy, the seller of CDS should have the ability to pay the buyer the par value of the bonds.

3.

The idea of momentum is that the price is more likely to keep moving in the same direction than to change the direction. With momentum strategy, the fund manager would have to look for security that shows a trend in a certain direction. If the security shows an upward trend, the manager would usually take a long position, and if it shows a downward trend, the manager would otherwise short sell the security.

Value strategy typically means selecting assets that are undervalued. In betting on options, we should not only see its current value, but also focus on the intrinsic value that might show up in the future. If the intrinsic value is higher than the market