Isda Agreement Big Short

The ISDA Agreement and its Role in The Big Short

The Big Short, a 2015 film, tells the story of the housing market crash of 2008 and the investors who bet against it. One of the critical players in the movie is the International Swaps and Derivatives Association (ISDA) agreement, which is a crucial document in financial markets. But what exactly is the ISDA agreement, and what role did it play in The Big Short?

The ISDA agreement is a standardized document used in the derivatives market. Derivatives are financial contracts that allow investors to bet on changes in the value of an underlying asset, such as stocks, bonds, or commodities. The ISDA agreement sets out the terms of a derivatives contract entered into between two parties- typically a buyer and a seller. It includes details like the notional amount, the underlying asset, and the payment terms.

In The Big Short, the ISDA agreement plays a vital role in the story of several investors who bet against the subprime mortgage market. They purchased a type of derivative called a credit default swap (CDS) from major banks, including Goldman Sachs and Deutsche Bank, that was supposed to protect them if the mortgage bonds failed. Essentially, the CDS was like an insurance policy, and if the bonds went south, the investors would get paid out.

The problem was that the banks were selling CDS contracts on a massive scale, without fully understanding the risks involved. As a result, they ended up with exposure to huge amounts of subprime debt that they couldn`t unload. They had essentially bet against themselves, and when the housing market started to collapse, they were left holding the bag.

The ISDA agreement comes into play when the investors try to collect on their CDS contracts. The banks refuse to pay, claiming that the mortgage bonds they had issued hadn`t technically failed. The investors then trigger the ISDA`s “credit event” clause, which forces the banks to recognize that the bonds had indeed defaulted. This clause is an essential feature of the ISDA agreement, as it ensures that both parties to the contract are on the same page when a credit event occurs.

In conclusion, the ISDA agreement is a crucial document in the derivatives market, and its “credit event” clause plays a vital role in the story of The Big Short. The movie shows how investors used CDS contracts to bet against the subprime mortgage market, and how the banks` overexposure to subprime debt led to a catastrophic collapse. While the events of The Big Short were undoubtedly devastating, they also underline the importance of transparency and risk management in financial markets.