Greek Cds Drama Holds Lessons for Investors Essay

1295 WordsFeb 6, 20136 Pages
Greek CDS drama holds lessons for investors (Oakley, 2012) On March 20th, 2012 Greece needed to make a €14billion payment on its huge outstanding debt but Greece did not have the money (Gilani, 2012). If Greece could not make this payment it would mean a default and investors holding Greek bonds would not get their money back. The investors being asked to swap the bonds they currently hold with bonds with lower face value and lower coupon, so they could get something as opposed to nothing (Oakley, 2012). But due to the terms and conditions, the bond swap constitutes a “credit event” that affected a default swaps holders (Oakley, 2012). A sovereign CDS is an over-the-counter credit protection contract when the insurance policy buyer pays a periodic fee (CDS premium or spread) to the protection seller (the credit-risk taker) until the contract matures or a credit event occurs, in which case the protection buyer delivers defaulted bonds to the seller in exchange for the face value of the issue in cash (Diekmann and Plank, 2012). A credit event, declared by the International Swaps and Derivatives Association (ISDA), triggered the payment process, known as auction. The auction held by 14 banks decides that outstanding CDS are worth $2.5bn and the CDS holders received 78.5% of net outstanding insurance whether they like it or not (Oakley, 2012). Before the default, the Greek CDS owners had the option: they could sell the CDS or they could hold on to their CDS position that means that CDS market remains liquid. The CDS were used for a purpose to hedge against falling bond valuations but now investors do not want to buy either sovereign bonds nor CDS as CDS are “flawed” (Oakley, 2012). The Greek CDS drama brought back the concerns that a few investors speculated with the prices on the CDS market that had adverse effect on the borrowing cost of sovereign state during

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