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I have been reading a lot of articles about JPMorgan Chase's (JPM) supposed "hedge" and how it "didn't work out as planned." Specifically, I have been trying to figure out exactly what they did, and, in basic terms, I think it was something like this:
- JPM purchased a lot of corporate debt.
- JPM hedged this corporate debt by purchasing some credit default swaps that make money if their original investment declines in value.
- JPM "hedged their hedge" by making highly leveraged bets related to the same corporate debt they originally invested in.
So, basically, No. 3 is the trade that blew up and lost the company $2 billion. This was not a hedge. Instead of reducing their credit default swap hedges, they added leverage bets correlated to their primary corporate debt exposure. A hedge reduces risk and reward. This trade increased risk and reward for the overall company.
It will be interesting to see what the fallout from this will ultimately be with regard to legislation and CEO Jamie Dimon's reputation, but for now I'll be happy if I just stop hearing the word "hedge."