By Daily Crux Editor Sean Goldsmith:
Hedge fund manager John Paulson of Paulson & Co. made a fortune in 2007 shorting the subprime mortgage market... He personally pocketed $3.7 billion for his genius trade. His hedge fund currently manages around $30 billion and is the third-largest hedge fund in the world. In this 2007 interview, when his subprime trade had already produced huge returns, he explains why shorting bonds is can be so profitable yet low risk...
From the article:
The beauty of shorting a bond is that the maximum you can lose is the spread over the benchmark; yet if the bond defaults, you can potentially make more. So it’s an asymmetrical risk-return tradeoff. In the case of subprime securities, we targeted the triple-B bonds, which are the lowest tranches in the subprime securitization.
In a typical securitization, you have 18 to 20 different tranches with the lowest … taking the first loss. The triple-B bond has about 5% subordination, meaning that if the loss is greater than 5%, the bond will be impaired.
And if it’s more than 6%, the bond will be extinguished. The yield was only 1% over LIBOR (the London interbank offered rate) so by shorting this particular bond, if I was wrong, I could lose 1%, but if I was right, I could make 100%. The downside was very limited but it had very substantial upside, and we like those types of investments.
Read full article...
More Paulson posts:
Billionaire golden boy sees distressed opportunities of "a lifetime"
World's top money manager goes waaaay long South African gold
