17
Jul

Credit Default Swaps (CDS) have been a good thermometer on the credit problems faced by banks and corporations. Given that they are insurance against defaults by companies they are marking higher levels as the credit squeeze has gone deeper into the economy. Increases in the probability of defaults has been accompanied with higher prices in CDS. Another away to look at is saying that the cost for companies of insuring against default has increased as firms face mounting borrowing problems. One of the problem of CDS is that there can be more policies written on a firm that the value of the firm itself. A simple way to look at this is thinking about your own house. On your own house you will probably buy enough insurance against many contingencies. The problem comes when also your neighbor and other people write policies on your house. You obviously do not care as it will not affect you. But truly the financial solvency of your insurance company could be jeopardized if this process took place not jus in your own house but in many others. The BBC produced a nice video where things are well explained. Check it out.

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Finance Weblog » What happens when your neighbor wants to insurance your house through a CDS? | IE Business School

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