FRM: Credit default swap (CDS) basis trade

[@Geotubest]

Thanks David Harper. I really enjoy your videos. Thanks for putting in the time and effort.

[@bionicturtle]

You're welcome George! Thank you for watching! :)

[@bionicturtle]

@talebi818 that's correct, in the "no aribtrage" (no basis trade or carry = 0), the bond yields +5% but it costs -2% to fund the purchase of the bond; i.e., naked bond = +3% net spread. Then investor hedges default by purchasing CDS at cost of 3% which brings carry to zero. So: +5 bond spread - 2% borrowing - 3% CDS = 0.

[@howeichin4103]

thanks for sharing!

[@LuvLondon2010]

if i get through my internship all right, you're part of success! x

[@Hamboarding]

4:28 Why is the CDS „expensive“ when it's trading at only 2% and the other way around in a Positive basis trad?

[@saigin]

thank you for this explanation....there's one gap in my understanding though. as an investor, why would one enter a positive scenario? i imagine the whole incentive for purchasing a bond is to have net positive cash flow from the interest. buying protection for more than the bond interest seems counter-intuitive...can you please help me understand the incentive for the investor in this scenario? thx

[@alperyldrm4788]

Great content! Thanks a lot!

[@esteban_ruiz]

Wonderful explanation

[@gargijain3800]

Normally basis is defined as the diference between rates in cash market minus those in derivative market. Then why is CDS basis = CDS spread - Z spread (derivative market - cash market)

[@saraabsar]

can you please also do CDS (options trade)?

[@talebi818]

So the investor is still getting the 5% yield even though he lost 2% from the repo and lost the 3% for the CDS?

[@adamgrimsley2900]

It can we worth investing because you lower risk with the same return

[@Geotubest]

David, not sure if you're around to answer this but...Is it safe to say that the neg or pos basis trades, due to market forces converging on arbitrage opportunities, do not last long in these cases? In other words, in practice are basis trade difficult to achieve?

[@bionicturtle]

Hello George. If you do not receive an answer from David here, I would suggest visiting our forum where David and other members answer questions daily. Please just make sure to reference this video if you are asking a specific question about it. Here is the link to our forum: www.bionicturtle.com/forum/. Nicole Bionic Turtle

[@Geotubest]

oh hey..Thanks a lot. I had no idea BionicTurtle had a forum. Looking really forward to visiting there. Thanks so much for your prompt response.

[@bionicturtle]

You're welcome! :)

[@annika4571]

whts point in investing when investor is not earning anything?

[@Geotubest]

There are two reasons to invest. As speculation and as hedging. When an investor intends to invest to not earn anything, it's a hedging scenario.

[@Bas1lio]

Why did you say “counterparty risk” instead of credit risk? There is no counterparty (or pre-settlement) risks in that deal, only credit to the CDS-selling body.

[@bionicturtle]

The "investor" (who purchased the credit protection; aka, long CDS) incurs counterparty risk exposure to the credit protection seller (aka, CDS seller, short CDS) per what I tried to say here kzbin.info/www/bejne/emXWaXyNha-qfZI

[@dreamsandcream]

thanks that was great

[@PureBadBreath]

Dumb question but have to ask. Why is the bond deemed cheap and CDS deemed expensive for a negative basis trade? Answers probably staring me in the face, but I'll swap ego for knowledge everytime.

[@rajashekarmaddineni7207]

Hi, Don't know whether my understanding is 💯 percent right. But I can share my understanding. In a negative basis trade, CDS spread is lower than bond spread i.e actual return on investment in CDS will be less when compared to bond. Hence we can say yield for CDS is less in comparison in bond which implies CDS is expensive compared to bond. Hope I was helpful. Do keep me posted if you have read the answer.