When companies short their own securities
BusinessWeek has an interesting article about CDS-linked lines of credit, where the cost varies in line with the borrower’s CDS spreads:
The lenders stress that the new products give them extra protection against default. But for companies, the opposite may be true. Managers now must deal with two layers of volatility—both short-term interest rates and credit default swaps, whose prices can spike for reasons outside their control.
Making matters more difficult for corporate borrowers: high fees. Banks are raising their rates for credit lines across the board—but the new CDS-based credit lines cost far more than the old lines. FedEx could end up paying $1.9 million to $3.6 million a month if it decides to tap a new line from JPMorgan and Bank of America. On its previous line with JPMorgan, FedEx would have paid about $540,000.
Companies the size of FedEx can easily hedge their interest-rate risk, using rate swaps. But how can they hedge their own credit risk? There’s only one way of doing that: by buying credit protection on themselves — the bond-market equivalent of shorting your own stock. That might be legal, but it’s certainly not pleasant.