Thursday, April 2, 2009

Country Risk of the G-20

Credit default swaps (CDS’s) are a type of insurance that one buys against the potential default on a loan/bond.*

CDS prices are quotes in the percent of the loan you have to pay up front to get the whole thing insured. When judging these prices, you need to recall that a basis point is 1/100th of a percentage point.

Alea has posted current CDS rates for most G-20 countries. The U.S., Germany and France are the lowest at around 60 basis points (that’s something like a 1 in 150 chance of default). The worst is Argentina at 3,750 basis points, or a better than 1 in 3 chance of defaulting.

For perspective, Lehman CDS’s were selling for 475 on September 10 (the week before they went belly up).

* Having to pay off the insurance to parties whose investments did go bad is the main problem with AIG over the last year. Other than that, CDS’s have gotten a bad reputation: experts are actually rather surprised that this market has functioned as well as it has given the circumstances. Pundits more or less predicted complete collapse in this market last fall, and it didn’t happen.

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