Know Your Data
As financial institutions bring new complex products to market, the underlying quality of the data is crucial. What if there is a change in the prepayment rate, default rate, or the original issuer ceases to exist? How transparent is the linkage between the issue and the issuer and all the subsidiaries? If there's a market change that affects the firm's risk and exposure, how quickly will it be reported? What's the valuation source and how was it derived?
Even as the subprime market crisis had institutions writing off $181 billion and saw the high-profile downfall of Bear Stearns, the market for derivatives expanded as investors bet on a world economic recession. Today, the value of the derivatives market is close to $600 trillion and growing, proof that derivatives are here to stay. Unlike traditionally traded products, the complexity of both structuring and valuing derivatives vastly increases inherent risk to both the buyer and the seller.
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