This is my favorite story in weeks.
So there is this little hedge fund called Amherst that just wanted to sell insurance. Just selling a little peace of mind. (I’ll show you the life of the mind!)
Anyway, they sold insurance against a bunch of subprime-mortgage-backed securities becoming worthless. They sold the exact same insurance over and over and over, then they used the proceeds to pay off the securities, and then they pocketed the $100 million or so surplus.
And the big Wall Street firms (hello JPM) that bought the now-worthless insurance are throwing fits. I love this story for so many reasons.
The moral is: Be careful when taking out insurance policies on somebody else’s property.
In other news, it may be a few days before the next installment of “Bond crash/course”, because (a) real life has intervened and (b) I am still doing research.
(By the way, anybody know how to calculate a swap spread? I know, I know, “subtract”. Beyond that, I mean…)
“Be careful when taking out insurance policies on somebody else’s property.”
Maybe the tranches were so difficult to dissect they had no choice but to “play the actuarial field” in order to hedge.
How to calculate a swap spread – hmmmm. This sounds like an ‘Ask any CFA question’ so at the risk of embarrassing myself, let me try. On a plain vanilla, fixed for floating interest rate swap, first calculate the fixed interest rate that gives the equivalent NPV to the floating rate stream of payments, then subtract the Treasury yield (on the instrument with the same maturity) from that fixed interest rate.