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Case Study

May 2005 Ford and GM downgrade

By Didier Cossin and Abraham Hongze Lu

20 pages

December 2006

Reference: IMD-1-0246

In May 2005, GM and Ford were downgraded and this created significant turbulence in credit, debt, and equity markets. This firm-specific event impacted financial markets, especially credit markets that had the largest sell-off since 2002. Unexpectedly, despite the widening of credit spreads, news of investor buy-in helped equity markets rebound. The links among credit, debt, equity and derivatives markets had been broken which led to huge losses for arbitrage players across different markets. Notably, hedge funds, which placed trades using capital structure arbitrage and correlation trades in credit derivatives markets, experienced significant decline in asset value. Investors and speculators alike were pulling plugs, liquidating unprofitable positions and rushing out of the door at the same time. The short squeeze created abnormal pricing discrepancies in credit and derivatives markets. Phil Berg, a credit hedge fund manager, faced the decision to profit from the pricing discrepancies, not in the peaceful period before the event, but in the turmoil after the event.

Learning Objective

This case gives MBA students an overview of the innovative history of credit derivatives markets and introduces them to the interrelationship of financial markets. The links among credit, debt, equity and derivatives markets are discussed in the context of a credit event which exposed the imperfections of the financial markets.

Keywords

Hedge Fund, Credit, Correlation, Banking

Settings

United Kingdom
May 2005

Type

Published Sources

Available Languages

English

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