Credit default swaps written on the sovereign debt of Latvia rose sharply on Thursday after its Prime Minister said it had missed out on a €200m payment from the International Monetary Fund. Latvia, which already has a €7.5bn rescue package from the Washington-based IMF, was refused the extra payment after its previous government failed to restructure its budget.
The previous administration collapsed in February after rioters took to the streets in Riga. Standard & Poor’s meanwhile had downgraded Latvia’s credit rating to “junk”.
Five-year Latvian credit default swap spreads rose by 70 basis points to 921 according to data provider CMA Datavision. This means it costs €921,000 per year to insure a notional amount of €10m against default over a five year period.
The market outlook for European corporate credit, however, improved, with the quoted bid/offer spread on both the investment grade and sub-investment grade benchmark CDS indices falling.
The five year Markit iTraxx Europe index of 125 investment-grade credits came in by 4.5 basis points to 170bp, while the spread on the iTraxx Crossover index of 45 mostly junk-rated companies narrowed by 23bp to 939bp.
Among the best performers were German luxury carmaker Daimler, which narrowed 13.5bp to 239bp after data showed a rise in new German car registrations in March. The cost of protecting Renault‘s debt against default for five years came down by 12bp to 417bp, while the CDS spread for Peugeot eased by 7.6bp to 412bp.
Credit default swaps are contracts by which one investor agrees with another to take on the credit risk of a third party in exchange for a flow of premiums over the life time of the contract.
The investor purchasing protection on, for example, €10m of a company or country’s bonds will usually receive the value of those bonds (usually minus the recovery value) from its counterparty if the reference entity of the credit default swap is judged to have defaulted.
A credit default swap can be used to hedge against the risk default or, on the other side of the trade, to gain synthetic exposure to a debt issuer and speculate on its creditworthiness.
The price of a contract is calculated by taking a basis point, or a one hundred of a per cent, figure of the total notional amount the contract is written on.