Question

1. What are sub-prime mortgages and how are they different from prime mortgages?

2. What are CDSs and how did they play a part in the mortgage collapse?

Answer 1

Sub prime and prime mortgages are type of loan provided to the borrower. Prime mortagges are provided to the people who have good credit history. Borrowers with credit history 620-650 qualify for prime mortgages. Whereas people with not so good rather bad credit history can qualify for sub prime mortgages the credit history could be 620 or below 600.

Credit default swaps (CDS)- played a role of derivative security it is like a cotract that ensures covering loss if it is becomes default. CDS played a major role in the collapse of mortgage in financial crisis 2008 they have played a major role in hiding the actual risk bearers as they are not visible on the financial sheets therefore risk borne by financial institutions was not visible. Thus lack of transperancy was one of the major reasons which led to the whole system to crash.