Last week JP Morgan Chase announced it was sitting on at least $2.3 billion in paper losses stemming from trading naked credit default swaps. These high risk derivatives are analogous to buying insurance on a house you don’t own – doesn’t make a whole lot of sense.
Initially credit default swaps (CDS) were introduced as a way to hedge against defaults on debt – bonds in particular. However, the practice of trading naked CDS (credit default swaps in which you do not have an interest in the underlying debt) became more and more popular.
JPMorgan Chase, one of the biggest financial institutions in the world, is now facing scrutiny for the huge losses it has amassed from trading these high-risk derivatives.
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