CDS, Bonds Or Basis Trade :
The ongoing crisis since 2008 have given the birth to lot of new jargon’s and terminologies in the world of financial market, I had tried to accumulate few of them from various sources and then will highlight an arbitrage strategy.
- [h]ypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is “hypothetically” controlled by the creditor, who has a right to seize possession if the borrower defaults.
In the U.S., this legal right takes the form of a lien and in the UK
generally in the form of a legal charge. A simple example of a is a mortgage, in which a borrower legally owns the home, but the bank holds a right to take possession of the property if the borrower should default.
In investment banking, assets deposited with a broker will be hypothecated
such that a broker may sell securities if an investor fails to keep up credit payments or if the securities drop in value and the investor fails to respond to a margin call (a request for more capital).
- Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds.
- so What exactly means a Bank sold $2 billion swaps on France :
It is an arbitrage strategy that looks to profit/earn carry from the difference between CDS
and Bond market
pricing of credit risk
. Typically it is created by buying bonds and simultaneously buying CDS protection (a hedge) to lock in a perceived valuation difference]
So if banks were selling bonds and selling hedges, then it would show up as reduced bond exposure but increased CDS exposure (they sell bonds, and sell CDS).