MBS Basics

MBS Basics.

Markit and DTCC form derivatives trade processing JV

Markit and DTCC form derivatives trade processing JV.

The partners say the new company will provide a single gateway for confirming OTC derivative transactions globally and the initiative will accelerate the adoption of electronic processing services across the rapidly growing $454 trillion OTC derivative market where around 50% of transactions are still confirmed on paper.

WSJ: Study Casts Doubt on Key Rate

Banks May Have Reported Flawed Interest Data for Libor.

Municipal Bond Credit Derivative Index

MarkIt MCDX (Municipal Bond Credit Derivative) Index has started trading on last Tuesday, May 6th.

MCDX, like its CDX and ABX counter parts, is an index of 50 municipal bond credit default swaps. The blog post here has a good deal of information on MCDX...

21: Monty Hall problem

An interesting problem raised in movie 21:

Suppose you're on a game show, and you're given the choice of three doors: Behind one door is a car; behind the others, goats. You pick a door, say No. 1, and the host, who knows what's behind the doors, opens another door, say No. 3, which has a goat. He then says to you, "Do you want to pick door No. 2?" Is it to your advantage to switch your choice?

The answer is somewhat counter intuitive: switch gives a 67% chance of winning while stay with original only has 33%. The way to best understand this is to give up your intuition, use the more fundentmental "decision tree" to evaluate the probabilities: (picture linked from wikipedia):

Another interesting probability topic of the movie is card counting in BlackJack...

The Week That Shook Wall Street: Inside the Demise of Bear Stearns

The past six days have shaken American capitalism.

WSJ's amazingly detailed count on what had happened last week that led to the collapse of Bear Stearns.

Deminishing $17 billion capital in one day is definitely giving new definitions to the term "bank run".

A bad weekend and a volatile week ahead

• JPMorgan to Buy Bear Stearns for $2 a Share
• Fed cut rate by another 25bps and Fed fund future now predicts a 100bp cut by Tuesday.
• And in the coming week:
• Fed meeting tomorrow.
• Triple Witch moves to Thursday because of "Good Friday"
• IMM roll date on Wednesday
• New Credit Indices coming out on Thursday as well

Very interesting time to watch ...

Bear Stearns Gets Emergency Funds From JPMorgan, Fed

BS is having a huge liquidity problem and its stock has gone down some 70% this year.
This is the second investment by Chinese Sovereign fund not turning out too well...

And the fear is driving clients flee from BS's prime brokerage business...

Articles on Credit Derivatives

A few interesting readings on Credit Derivatives:

• FT.COM article on correlation and CDO tranche pricing.
• NYT article mentions some of the interesting aspects of CDS settlement, including the novation notification and cash v.s. physical settlements.
• Barclays Capital research on CDS counterparty risks.

Credit Suisse Writedowns

Write downs are not really news any more, but Credit Suisse's reasoning behind it is still worth noting:

Switzerland's second-largest bank took $2.85 billion of writedowns on asset-backed securities after an internal review found ``mismarkings'' by a group of traders and debt markets deteriorated. The Zurich-based bank said in a statement today that it's assessing whether 2007 earnings were also affected.

Now if a financial firm is still relying on traders to mark the price of securities, it's ought to be in big trouble... Where are the Risk Managers?

Rogue Trader at Societe Generale

Jerome Kerviel, the French trade from Societe Generale, is now on top of the rogue traders list. We see many other familiar faces on that list: Mr. Copper, The Orange County Treasurer and Mr Kerviel's predecessor, Nick Leeson.

Another interesting point is the potential "butterfly effect" of Jerome's action: The unwinding of his lossing trades became a major force behind the sharp market decline around the globe on Monday, which then pushed the Fed to cut rates by another 75bp and eventually led to one of the most volatile week in the history of wall street...

Players in the back office of wall street

Some players I have learnt recently in the course of my work:

• DTCC Deriv/SERV: Providing matching and settlement services for OTC derivatives, notably, credit default swaps. An interesting point is that DTCC provids the Master Confirmation Agreements on these CDS trades so that its participants can delivery trade confirmations in the "short form", and avoid signing bilateral confirmation agreements with each dealers.
• CLS Bank: Performs settlement and netting for FX transations on a global basis, which greatly reduces counter party risks compare to the more traditional way of settling FX trades (i.e. settle each leg of the transation separately).
• Prime Broker and Give-up Trades: When the client uses prime broker for certain FX trades, the executing broker must "give-up" trade details on these transactions to the prime broker for further process (settlement, legal confirmation, etc.)

Model accuracy in different markets

Model accuracy in different markets from Paul's latest blog entry.

The dynamic relationship between just two equities can be beautifully complex, and certainly never to be captured by a single number, correlation.

There goes your reason why the CDO business is in deep trouble now...

S.W.I.F.T

It must be quite a long time since my last attempt to read some scrambled text. Yet here I am, trying to make sense of a SWIFT message, one of the standard wire formats for Wall Street's backoffices:

{1: F01BANKBEBB2222123456} {2: I100BANKDEFFXXXXU3003}...

Trust me, you don't want to read the official SWIFT Handbook unless you are having sleeping problems. Luckily, I have found a one-page introduction to SWIFT format in an odd place --- IBM WebSphere documentation.

How municipal bond insurance works

With Warren Buffett getting into Muni Bond Insurer business, it's time to get a lesson on how municipal bond insurance works.

Merrill May Get $5 Billion Investment From Temasek

Bloomberg news here.
Merrill has become the latest to join the league, turning to Singapore for capital infusion.

Morgan Stanley Posts Loss, Sells Stake to China

Morgan Stanley reported a steeper- than-forecast loss after $9.4 billion of writedowns on mortgage- related holdings and received a $5 billion cash infusion from state-controlled China Investment Corp.

A rather special phenomena in the current credit crisis is that the troubled institutions are turning to the reserve-rich developing governments for capital infusion. Notably China (Bear and now Morgan), Singapore (UBS) and Abu Dhabi (Citi). While the more traditional "white-knights" such as Warren Buffett have not shown up in the headlines much.

This could mark a sea-change in the emerging market investing paradigm: instead of being driven into the boom-bust cycle by FDI, now these EM economies are in the driver's seat investing their own capital elsewhere. Can they pass the road test? Guess we have to wait and see...

How Goldman Won Big On Mortgage Meltdown

In today's journal.

Ducking the Subprime Hit

 

In today's Journal:

Asked yesterday if the firm would take the sort of significant write-down facing many of its peers, Mr. Blankfein answered with a succinct "No." Given the continued, challenging conditions in the trading of complex mortgage products, "we continue to be net shorting these markets," he told the crowd.

High Grade ABX-HE indices

According to the press release, Morgan Stanley used ABX indices as a reference point for its ABS asset valuations. Looking at the changes in high grade (AAA) ABX-HE index in the last couple days, it seems that there might be more to write down post Oct 31^st.

 

Makes me wonder how other "smarter" banks (read: GS and LEH) are holding up in this climate.