If I place a $5 bet on a game between two $1 billion dollar sports teams, is my bet somehow worth $2 billion?
The problem, as I understand it, is that people have borrowed money on these assumed values. A whole lot of debt that has nothing underneath it.
That’s not how credit derivatives work. Think of it as insurance for the loss of an investment.
Here's a better sports analogy, if I understand derivatives correctly (and perhaps nobody does). Suppose it's the New England Patriots vs. the Jacksonville Jaguars.
You issue notes, at $5 apiece, promising to pay each bearer $1 million dollars if Jacksonville wins by 35 points or more. Now suppose 1000 people take you up on that. Those folks might have bet on the Patriots, but want to hedge their bets a bit.
So now there is $1 billion dollars of derivatives on the line (the note's value is "derived" from some other value, in this case the game's final score). You better hope that Jacksonville doesn't win by 35 points or more. Because if they do, your company is going to collapse spectacularly.