CDS report: Spreads hit record highs, entering "wild and inexplicable" territory

European credit spreads surged to record highs on Friday, breaking through levels that analysts fear could represent a tipping point.

Spreads on the iTraxx Europe index, which measures the cost of protecting 125 investment-grade credits against default, hit 156 basis points in morning trade, entering territory where sudden feedback effects come increasingly into play.

“The 150bp level is a significant threshold,” said analysts at BNP Paribas. “According to our calculation, it is where a “typical” CPDO may be forced to unwind its risk portfolio and trigger a cash-out event.”

Liquidating CPDOs and other structured credit instruments requires buying large amounts of protection using credit default swaps. This, in turn, drives the cost of protection higher, potentially triggering a chain reaction.

“There is potential for some wild and possibly inexplicable price movements as the unwinds get bigger,” the analysts said.

While many analysts play down the importance of CPDO unwinds, countless other structured products — as well as hedge funds and banks — are coming under intense pressure to cut their losses.

Any optimism that the market might escape further violent swings has become increasingly rare. BNP Paribas said: “While deleveraging has taken an accelerated path since the beginning of the year, we believe that this is only the beginning of a trend which will look to unwind the excesses of the last few years.”

In recent days new horrors surfaced from the hedge fund world. As credit spread have risen, highly-geared funds have come under increasing pressure from uneasy investors who want their money back, and brokers terrified on counterparty risk.

Willem Sels at Dresdner Kleinwort said: “Price changes, multiplied by leverage, leads to redemption risk and margin risk, which ultimately also leads to unwind risk. This creates a technical sell-off as the unwinds happen in a bearish market.”

The trauma in credit derivatives markets in not contained to Europe. Equivalent indices in the US and Asia are also hitting record highs.

Redemption risk, margin risk, unwind risk ????? I thought speculation is "risk-free" ????

http://ftalphaville.ft.com/blog/200...ghs-entering-wild-and-inexplicable-territory/

 

Suss-----did you pay cash or take out a 120-month loan for your Lambhorghini?

 

Nazz,

Lambhorgini ? Not my preferred mean of transportation...

Regarding option cash payment / taking out a loan, here´s a classic answer :

Opportunity cost is the cost incurred (sacrifice) by choosing one option over the next best alternative. Thus, opportunity cost is the cost of pursuing one choice instead of another.

 

?.......OMMFG! Did you buy a Vespa scooter instead?