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Asset Managers Using Derivatives in Place of Mortgage Bonds

Reuters reports that many asset managers are using derivatives to gain exposure to commercial mortgage-backed securities rather than purchasing the bonds themselves.  The notional value of these derivatives has increased by $40 billion from a year ago, while the supply of the actual bonds has declined.  The article notes “[w]ith investors increasingly wary of buying cash bonds exposed to aggressively underwritten loans, a synthetic exposure to a wider group of CMBS has come into vogue as an investment alternative in volatile markets.”  The liquidity of commercial mortgage-backed securities has fallen as volatility in the cash bonds has risen, trading desks are working with reduced staff, and post-crisis financial regulation has reduced large banks’ ability to trade.

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