The benefit of the $20-per-textbook subsidy was split evenly between buyers and sellers. However, the actual distribution of this benefit will depend on the elasticity – always be shifted toward the more inelastic side of the market. Thus, the more inelastic
just as it does with a tax. The benefit of the subsidy will the supply, the larger the share of the benefit that will accrue to sellers. On the other hand, ties of supply and demand the more inelastic the demand, the larger the share of the benefit that will accrue to buyers. Using our earlier examples from the posts on taxation, consumers would be the main beneficiary of a subsidy on gasoline (a good for which the demand is relatively inelastic, and supply elastic), while suppliers would be the main beneficiary of a subsidy on luxury boats (a good for which demand is relatively elastic, and supply inelastic). Economic analysis indicates that the true benefit of a subsidy will: (1)be the same regardless of whether the subsidy is granted to the buyers or sellers in a market, and (2) will depend on the elasticities of supply and demand.
Benefit of the government subsidy program
December 5th, 2009A principal-based payment
December 1st, 2009The contract could be structured as a straight insurance policy that pays out a defined amount in the event of a trigger condition being met, such as a payment being missed, the company seeking bankruptcy protection or being liquidated.
Credit derivatives are not traded on exchanges but are further examples of instruments that are traded OTC (over-the-counter). They provide a way for insurance companies to compete with banks. By issuing credit derivatives they can enhance the credit quality of a company’s debt and make it easier to sell. In this way they are going head to head with banks in terms of pricing credit risk.
A bank may buy credit derivatives even if it has no direct exposure to the underlying company as proxy insurance. If a bank, for example, has exposure to a number of suppliers of a particular company buying a credit derivative against this company will reduce risk. Its suppliers will be adversely affected if the company cannot pay its bills. That in turn will impact on their ability to service their debt.
An insurance company may write a credit derivative on a company where in its view the market is mispricing default risk. If the writer of the policy is also a lender to that company it may have an inside track on the likelihood of a trigger condition being met. In this case the bank’s incentive is to sell an option that the bank believes will expire worthless.
Credit derivatives are only likely to be successful in markets where there is perceived to be a high degree of transparency and high standard of corporate governance. In emerging markets this is rarely the case and as a result credit derivatives are largely confined to developed markets such as the US and UK. The word “perceived” used here was chosen carefully.
A spread-based payment
November 27th, 2009The credit spread is measured by comparing a company’s bond yields against those of Treasury notes with similar structure and term. If the bond’s credit spread rises above a predetermined level the contract pays out on a notional principal outstanding based on the difference between the actual spread and that defined in the contract.
This is best illustrated with an example. Suppose that the contract is for a notional principal of $100m and that the issuer will pay out if the credit spread reaches more than 500 bpts above the yield on a specified, comparable Treasury note. At 600 bpts the annual payment from the issuer of credit derivative would be $1m.