Trade Compression (Gregory)
- Thread starter Delo
- Start date
Trade compression in simple terms is the replacement of the multiple trades/contracts with several counterparties with a single one, in technical terms, the various trades are compressed into one trade with a single counterparty, thus reducing the number of counterparties. Note that Compression is an extension of bilateral netting where the Amount of the Transaction that remains after Netting is further reduced, this is called reduction of the notional amount of the transaction.
Compression requires that the Contracts are the same or similar ( called fungible ) so that they can be interchanged by executing new contracts (novation) to reduce the Notional Amount and the number of counterparties.
In your example above, we can see that the CDS is on the same reference entity which makes it a likely candidate for Compression. Assuming that the three counterparties have similar risk profiles and have entered into a "gentleman's agreement"
with our friend going long/short the CDS to reduce their exposure to our friend as well as themselves through compression,
We calculate the weighted average of Notional times the Coupon;
40*200 = 8,000
25*150 = 3,750
10*325 = 3250
Total
75 15,000
So the average coupon is 15,000/75 = 200
As he is long Counterparty A and Short the others, the reduction in notional turns out to be 40-35 =5 Long with Counterparty A with a coupon of 200
Hope this helps
Compression requires that the Contracts are the same or similar ( called fungible ) so that they can be interchanged by executing new contracts (novation) to reduce the Notional Amount and the number of counterparties.
In your example above, we can see that the CDS is on the same reference entity which makes it a likely candidate for Compression. Assuming that the three counterparties have similar risk profiles and have entered into a "gentleman's agreement"
with our friend going long/short the CDS to reduce their exposure to our friend as well as themselves through compression,We calculate the weighted average of Notional times the Coupon;
40*200 = 8,000
25*150 = 3,750
10*325 = 3250
Total
75 15,000
So the average coupon is 15,000/75 = 200
As he is long Counterparty A and Short the others, the reduction in notional turns out to be 40-35 =5 Long with Counterparty A with a coupon of 200
Hope this helps
Perfect. Thanks a lot .. @QuantMan2318 !
FrmL2_Aspirant
Member
if in the above e.g., both c/p as well as ref entity are the same, can we also net the coupon, instead of taking its weighted average?
@FrmL2_Aspirant if we netted the coupons, I *think* we'd get the same result as the weighted average performed in @QuantMan2318 's calculations; i.e., -(40*200) + (25*15) + (10*325) = -8,000 + 3,750 + 3,250 = -1,000. But rather than pay a net $1,000 as the result of three cash flows, the new contract pays a net $1,000 on one contract. QuantMan probably knows more about this than me, but the trade compression looks like an alternative to netting, sort of like a permanent netting. Thanks,
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