Via Alea, a Reuters story about a new Citigroup product where you can apparently buy default protection at zero initial cost, paying only if and when the defaults start happening. There’s just enough information in the article for it to be intriguing, but not quite enough for it to make sense.
I understand that if the defaults happen, then the cost of protection is higher than it would have been if you’d bought it up-front. But at that point you don’t care — you’ll happily pay a lot of money to protect yourself against a certain default. Can someone explain to me how this product works? Can you really buy protection and yet pay absolutely nothing if nobody defaults?
Reading only what you’ve read, it looks like you’re short protection early in the contract, and long protection later on. It also looks as though it’s designed such that you won’t suffer any large cash-flow event; if a default takes place early, the NPV should obviously be written down by quite a bit, but the actual payments are spread out. It looks as though this cash-flow characteristic of it is the marketing hook; it’s the sort of thing, like a carry trade, that the finance books say aren’t supposed to make you money, but which appeal to hedge funds anyway.