Nov. 7 (Bloomberg) -- Credit-default swaps on bonds of Citigroup Inc., Wachovia Corp. and Morgan Stanley are trading at the highest in at least five years on speculation the nation's biggest banks may be forced to write down more subprime assets.
Analysts began revising predictions for writedowns at the banks after Citigroup this week said losses from the assets may rise to $11 billion. Credit-default swaps tied to Citigroup more than tripled in the past three weeks, indicating the risk of default is rising. Contracts on Morgan Stanley and Wachovia Corp. and Merrill Lynch & Co. are at or near six-year highs.
http://www.bloomberg.com/apps/news?pid=20601087&sid=auTmbruMWHfw&refer=home
A credit default swap (CDS) is a bilateral contract under which two counterparties agree to isolate and separately trade the credit risk of at least one third-party reference entity. Under a credit default swap agreement, a protection buyer pays a periodic fee to a protection seller in exchange for a contingent payment by the seller upon a credit event (such as a default or failure to pay) happening in the reference entity. When a credit event is triggered, the protection seller either takes delivery of the defaulted bond for the par value (physical settlement) or pays the protection buyer the difference between the par value and recovery value of the bond (cash settlement).
Credit default swaps resemble an insurance policy, as they can be used by debt owners to hedge against credit events. However, because there is no requirement to actually hold any asset or suffer a loss, credit default swaps can be used to speculate on changes in credit spread.
Credit default swaps are the most widely traded credit derivative product[1]. The typical term of a credit default swap contract is five years, although being an over-the-counter derivative, credit default swaps of almost any maturity can be traded.
http://en.wikipedia.org/wiki/Credit_default_swap
Buying Swaps
Credit-default swaps tied to Citigroup's bonds have climbed 17 basis points to 70 basis points since Oct. 31, according to broker Phoenix Partners Group in New York. The contracts are trading at the widest levels since at least September 2002, data from Credit Suisse Group show.
A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
At that level, Citigroup is trading as if it were rated Baa3, the lowest investment-grade rating, according to the credit strategy group at Moody's Investors Service.
Moody's this week lowered Citigroup's ratings to Aa2, its third-highest rating, from Aa1.
