Case Detail

Case Summary

Betting on Failure: Profiting from Defaults on Subprime Mortgages

Case Number: 5-312-504, Year Published: 2015, Revision Date: May 26, 2016

HBS Number: KEL879

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Authors: Craig Furfine

Key Concepts

Cash flow analysis, Financial analysis, Financial instruments, Financial strategy, Real estate, Securitization, Mortgage-backed securities, Credit default swaps, Subprime, MBS, CDS

Abstract

In October 2008, in the midst of a financial crisis, Anthony Keating, investment manager at the Boston private bank Billingsley, Blaylock, and Montgomery, was searching for an investment strategy to recommend to his high-net-worth clients. Traditional investments in the equity markets were being decimated, and Keating’s clients would be looking to him for ideas. Inspired by the success of Paulson and Co., Keating began to explore the possibility of entering a trade that would profit as homeowners defaulted on their mortgages. The more Keating learned about the trade, the more he realized that he needed to know about mortgage-backed securities and credit default swaps. The case provides instructors with a chance to introduce these financial instruments, while at the same time providing lessons applicable to students interested in value investing or real estate finance.

Learning Objectives

After reading and analyzing the case, students will be able to:

  • Explain how home mortgages are securitized into financial instruments that are traded in public markets
  • Describe how credit default swaps can be used to speculate on the value of an underlying financial instrument
  • Identify potential mispricing across related financial instruments
  • Understand the potential risks and rewards of various financial investment strategies that look to capitalize on defaults on subprime mortgages

Number of Pages: 25

Extended Case Information

Teaching Areas: Finance

Teaching Note Available: Yes

Geographic: Boston, Massachusetts, United States

Industry: Banking

Organization Name: Fictional

Decision Maker Position: Investment manager

Decision Maker Gender: Male

Year of Case: 2008