CHAPTER 8: Share and share alike - derivative inequity
This chapter is about what probably is the most traded instrument: equities. According to the author, Equity derivatives were the hottest financial instrument in the 90’s.
Author quotes the situation as, “I came from a bond background where you put up your money, you know what interest you get, and at the end, you get your money back. With shares, the only similarity to this is that you put up the money. You have no guarantee that the company will pay dividends or how much, if any; you don't get your [same] money back, ever. If you want your money back you need to find another punter to buy the stock from you. The company can issue new shares, reduce the value of your holdings, they can buy back shares, they can change your rights. And if things go wrong, everybody gets paid before ...view middle of the document...
Stock Dealers intervened into the situation and tried to gain from it and on the other hand, tried to set it out right. They bought the shares from foreign investors, and in turn sold the equity option to the foreign investors, which gave the investor, right to purchase the UK stock which was a deep in money option. The foreign shareholders now no longer received dividends, but they received the raise in stock price above the strike price, the whole arrangement was made to keep the withholding tax under check.
CHAPTER 9: Credit where credit is due - Fun with CDS and CDO
Everything you wanted to know about a good part of the cause of our current troubles.
The author discusses that credit is like glue: once you take on risk, you can't get rid of it easily. CDS are then created to sell the risk to someone else. Mr. Das also shows that the stuff can get so complicated that sometimes you do not even know whose risk you are buying.
Here, he explains the pattern in which the commercial banks take credit risk and the way investment banks do. The competition between the commercial and investment banks shapes the credit market. Initially the investment banks were not happy with the arrival of commercial banks into the credit market, many investment banks got sunk, many got acquired by the commercial banks due to the low interest rates that the commercial banks had, which attracted many customers, however the moment the investment banks entered into credit market, the game became interesting.
MBS, mortgage backed securities are discussed and the birth of Collateralized loan obligation (CLO) and CDO (Collateralized debt obligation) from MBS has been explained, as in how MBS led to the birth of CDO and how are they different from each other.
Another new learning was about Tranches, which we understood were small segments of mortgages with different maturities.