From the December 01, 2007 issue of Futures Magazine • Subscribe!

Credit Derivative Strategies: New Thinking on Managing Risk and Return

Edited by Rohan Douglas

Bloomberg Press

$79.95, 224 pages

The problem starts in the book’s introduction. The editor writes, “All potential investors ask: ‘How do I choose among the many investments and strategies?’” Unfortunately, that is the wrong question. It is a beginner’s question. An experienced trader would ask, instead, “Given what I know of the markets and given who I am, is there anything here that will help me make money. And, if so, what other knowledge and skills do I need to make this work?”

Unfortunately, to use the material in this book, you must know or learn an immense amount of other material. For example, credit spreads are a function of the difference between default distributions of debt instruments or portfolios of debt instruments. A default distribution is each possible default times the probability of that default taking place. Think profit and loss histograms from the future where only the bad outcomes are presented. This book disposes of this topic with 12 pages and one footnote.

The book offers interesting materials and trading ideas in areas not often addressed. Even better, while this topic is inherently numerate, the book’s mathematical level is modest.

On the negative side, this means you will have to go elsewhere to learn the necessary math if you decide to go further. Worse, too many acronyms makes it difficult to read. Even worse, much of the thinking is sloppy. Consider, for example, “The wide variety of valuation approaches available reflects the diverse use of credit derivatives. Each of these approaches has different strengths and weaknesses, and the right choice depends on the intended use.”

The authors then list mark-to-market, hedge calculates, portfolio optimization and four other valuation strategies. Actually, there is mark-to-market, there is guessing and there is nothing else. Some guessing techniques are better than others, of course, but there is a near infinite distance between actually having a price and guessing. If you are not going to do the necessary work, this book will only help you lose your money. Still, if you are sufficiently critical and willing to do additional research, this is not a bad place to start.

Fred Gehm is a consultant to hedge funds and fund of funds. He is also the owner of the pro-investor, anti-BS website:

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