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Briefing

Cash Bond - CBS Basis Comparison

Appears in: Corporate Bonds and Leveraged Loans

Background:

A "basis" is defined by the CDS spread minus cash bond spread. According to Walter Kurtz with SoberLook, "given that the basis trade was a hedged trade (long credit and long protection), prime brokers provided significant leverage such as 20:1. But as funds went searching for liquidity with redemptions looming, they unwound the trade, forcing the basis spread to widen. As it widened, prime brokers asked for additional margin to support losses on the trade. Margin calls on the leveraged trades forced a spiral of unwinds, creating the largest widening of basis spread ever." Many large trading houses from Deutsche Bank to Merrill Lynch have been caught wrong footed on basis trades. As credit markets reopened, the sharply negative basis narrowed again but without closing altogether. It may be that without the pre-crisis leverage levels, engaging in the basis trade may simply not be worth the while.

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