Guest Post: What Does It Mean If Greece CDS Is Trading At 2000 bps?

From Peter Tchir of TF Market Advisors

What Does It Mean If Greece CDS Is Trading At 2000 bps?

In the past few days reporters from Bloomberg, Reuters, and the FT have all basically said the spread is a per annum fee to insure against Greek default.  That is not actually correct.  If someone buys 10 million of 5 year Greek CDS at 2000 they do NOT pay 2 million per annum until the maturity or a Credit Event occurs.  They pay 500,000 annually, quarterly in arrears until the scheduled maturity date or a Credit Event occurs, AND they pay 3,662,325 up front. This is a big distinction.  It is true for all CDS.  The quoted running spread is converted to an upfront payment based on an actual running spread of either 100 bps or 500 bps depending on the name.  Certainly for tight names, this difference is more of a technicality, but for distressed names it is meaningful.

I don't think anyone in their right minds would sell Hellenic Republic CDS at 2000 bps running.  That would entitle them to earn 20% per annum, quarterly in arrears until maturity or a Credit Event occured.  So if you wrote that CDS on Monday and there was a Credit Event the next day, you would have made 1 day of interest and now lose 100 - the price of the cheapest to deliver bond.  About 55 points (assuming cheapest bond is trading at 45 right now).  That is a very different risk/reward profile than receiving or pay 36 points up front.  If that case, if there was a default tomorrow, you would lose about 19 points, again assuming a cheapest to deliver bond of 45, giving a loss of 55 points on the contract.

The prices quoted at in bps, but there is an actual price associated with each spread and right now for Greece it is around 35 points up front.  That is accurate.  Any article that merely converts it to a running per annum fee is plain wrong.

Is 35 points up front the 'right' price for 5 year CDS.  I don't know, but it is roughly the current market price.  The Greek yield curve is inverted, but shorter dated bonds still trade at a higher dollar price than longer dated bonds.  Is that right?  Again, I don't know, but that is where the market is today.  The shape of the yield curve, the actual prices for bonds, and the CDS market are related and can be evaluated for the best investment ideas, but it is important to be using the right data, and reporters need to start accurately stating what it costs to buy or sell CDS on Greece and other entities.


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