As the subprime mortgage writeoffs get larger everyday, heres a look at the pricing of credit derivatives in the sector.
" Markit was founded in 2001 as the first independent source of credit derivative pricing.
Working in conjunction with a consortium of key asset-backed security trading desks, Markit acts as administration, calculation, and marketing agent for ABX. Under this broad remit, Markit will provide a number of services and functions to facilitate the transparency, liquidity and standardisation of this new benchmark index.
The ABX Index is a series of credit-default swaps based on 20 bonds that consist of subprime mortgages.
ABX contracts are commonly used by investors to speculate on or to hedge against the risk that the underling mortgage securities are not repaid as expected.
The ABX swaps offer protection if the securities are not repaid as expected, in return for regular insurance-like premiums.
A decline in the ABX Index signifies investor sentiment that subprime mortgage holders will suffer increased financial losses from those investments.
Likewise, an increase in the ABX Index signifies investor sentiment looking for subprime mortgage holdings to perform better as investments. "
8 NOVEMBER 2007:
Lastly, What are Credit Default Swaps?
According to Investopedia - They are swaps designed to transfer the credit exposure of fixed income products between parties.
The buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product.
By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap.
For example, the buyer of a credit swap will be entitled to the par value of the bond by the seller of the swap, should the bond default in its coupon payments.
............trouble is, subprime has begun to default!!!!