Question

Why would a counterparty purchase a credit default swap (CDS) or mortgage backed security (MBS) offered by a bank?

Answer 1

Counterparty will like to buy the credit default swap (CDS) from the bank because banks would want to hedge their position against riskier projects, non-occurrence of projects would force the counterparty to make the payment to the banks. In return counterparties will receive premiums that the banks will have to pay; now every risky project might not crash out and hence although the downside remains the upside of collecting fees (in the form of premium) remains huge. Counterparties also buy mortgage-backed securities because these are safe modes of making steady income over a period of time. The liquidity for the MBS market is readily available in the secondary market as parties can transfer and release their holdings before the end of the maturity.