Friday, April 27, 2007
Macro Man’s email box has been polluted on several occasions recently with solicitations for and explanations of a range of “exciting new financial derivative products.” Specifically, investment banks are sending out an increasing amount of drivel about things called CCOs and CFXOs: collateralized commodity obligations and collateralized foreign exchange obligations. If ever there was a solution for a problem that didn’t exist, this crap is it.
To quote a recent solicitation: “while this is a modification of CDS translated into FX space, we can see that this actually closely resembles a well-defined FX product, namely a one-touch option.”
In other words, there is already a liquid and easy-to-understand product where the market and credit risks are transparent. These banks wish to replace this product with an illiquid, opaque structure where the market risk is similar but the credit risk is an additional variable. This begs the question of why end users do not simply replicate the payout profile of this junk by combining traditional one touch options with conventional credit default swaps.
Macro Man has generally pooh-poohed those worry warts who view derivatives as the paving stones on the road to Financial Armageddon, but this rubbish certainly gives him pause for thought. A word of warning to anyone considering buying this junk: in all likelihood, the people who structure this stuff get paid more than you. Before buying, ask yourself where that money comes from!