Betting on Failure:

Profiting from Defaults on Subprime Mortgages

October 24, 2008, was a brutal day in the U.S. equity market. Or, as Anthony Keating thought to himself, another brutal day: the S&P 500 index had dropped another 3.5 percent, ending the session 25 percent lower than it had been only three weeks earlier. Although market declines were bad for most investors, they were particularly troubling for Keating; as one of four investment managers at the Boston private bank Billingsley, Blaylock, and Montgomery (BB&M), he was supposed to be generating positive returns for his high-net-worth clients.

He had started to think it was impossible to make money during the ongoing financial crisis until he read in the Wall Street Journal that the giant hedge fund Paulson and Co. had racked up gains of more than $15 billion in the previous year. Paulson's strategy was described only cryptically, but it involved buying credit default swap (CDS) protection on subprime mortgage bonds (MBS).¹

After some research into CDS and MBS, Keating thought that Paulson's strategy might still generate significant profits for his clients if he bought CDS on a bond backed by subprime mortgages from California, where the housing market was deeply distressed. If, as he expected, the underlying MBS suffered principal writedowns, the bonds would be worth nothing, and he would receive the full notional value of the CDS contract.

Betting his clients' money on unfamiliar instruments made Keating a little cautious. However, the equities market seemed to offer no opportunities for positive returns, so he had to decide whether to invest his clients' money in a CDS on MBS trade, and if so, how to structure the trade.

QUESTION:

Hi there

I am working on my final project. I choose case study Betting on failure: Profiting from default on subprime mortgages. I am stuck with the following questions

Risks and Benefits

A. Discuss potential risks and benefits associated with each instrument and how those risks could have an impact on return.

B. Assess the impacts of multiple extrinsic and intrinsic factors that the company will want to consider based on how they influence value and price.

Price Impact (Spreadsheet Appendix)

A. Calculate the potential price impact of extrinsic and intrinsic factors, and expected mitigated risk value of recommended derivative instruments. Present this information in your spreadsheet, and include it as an appendix.

My recommendation were option contract, forward contract, and Swaps. I need help to prepare the spreadsheet.