Credit Default Swap for my business

[Southern_Lenders]

It's been said that the credit default swap is in the center of the market crisis, however for my business I'm trying to start, I'd need a way to insure myself against loss....CDS's can solve this problem.

How it works:

1. Say I start with 125,000 capital, and loan this money to 250 people, for 500.00 each at 12.5% interest (this is a payday loan due back in 30 days)

2. This should generate $15,625 in interest IF everyone pays back their loan.

3. Of course there is the risk that some dont pay back. I would find a seperate wealthy investor willing to take the risk. I would pay him 5% of the future interest earnings of 781.25 a month as a "interest premium"

4. Should someone default on their loan, he would pay me 562.50 per defaulted borrower. If no one defaults and everything goes as planned, this is 781.25 dollars in his pocket.

Anyone here interested in enter such a partnership, should the legal enviroment allow it?

[akula]

it's a good question..
i'd probably turn you down
the whole rationale of charging a 310% annual rate is that a large number of borrowers are gonna default...leaving me in a lurch
people who pay back loans don't usually borrow at 310% p.a.
....that said, what's the default rate for pay day loan industry?

[Southern_Lenders]

The rate in most states is 17.5% and normally not any higher than 500.00 for a 14 day term. It's brutal, so i've herd

I'm putting mine at 12.5%, and giving a whole 30 days to repay + some other lil perks.

There has been talk in congress of capping payday rates to 36% APR, but at that low a rate, it would put just about everyone out of business and therefor is not feasible. I don't think it will happen

Considering how bad unemployment is, why shut down an entire 40billion dollar industry? That would be incredibly stupid imo.

[cg410]

There's nothing wrong with a credit default swap, but no one is going to take 100% of your risk for 5% of your gain. If 2 out of 250 borrowers default, the investor loses. The realistic default rate is more like 50 out of 250.

[Southern_Lenders]

Well thats the way all insurance works. you pay a small fraction of the cost, for whats at risk, and the insurance company promises to pay you back, should such loss accure.

[cg410]

I understand how insurance works. My point was that the "insurance premium" that you were offering is too low by a factor of about 25.

If you want to calculate a reasonable insurance rate, find out what the average loan default rate is for payday loan in your area and multiply that by the aggregate loan value, then expect to pay slightly more than that. For example, if you wanted to loan $125,000 and you knew that on the average, 25% would default, your "insurance premium" would have to be greater than $125,000 x 0.25 = $37,500 to be attractive to an investor. Note that in this case, the insurance cost would be greater than your profit, so you either need to bring down the likelihood of default (perhaps by requiring some kind of security) or bring up the APR.

--Jon