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Morgan Stanley Shares Plunge

NEW YORK ( TheStreet) -- Shares of Morgan Stanley (MS - Get Report) were down more than 6% on Monday afternoon, as investors worried about its exposure to European banks, despite several analyst reports that said the fears were unwarranted.

The cost of protecting against default by Morgan Stanley for five years rose to 456 basis points in the CDS market. In other words, it costs Morgan Stanley bond investors $456,000 to insure $10 million of debt. That is up from 305 basis points on Sept.15.

Investors appear to consider the investment bank less credit-worthy than Bank of America (BAC - Get Report) which has CDS trading at 403.

Other press reports have noted that the investment bank's CDS is trading higher than some French banks. That is ironic considering that investors are supposedly concerned about Morgan Stanley's exposure to French banks.

A report by finance blog Zero Hedge last week pointed out that the investment bank had a $39 billion exposure to French banks as of December 31, 2010, 60% more than its market capitalization. Analysts have since debunked the report.

According to Brad Hintz, analyst at Sanford Bernstein (and a former managing director at Morgan Stanley), the total cross-border exposure reported by Morgan Stanley includes all funds held in French bank accounts (including its client funds),the firm's gross reverse repo positions and gross security borrows. It "excludes net repo positions by counterparties and collateral posted to Morgan Stanley during a trade." In other words, its exposure has been overstated.

Still, the fears have not been put to rest. The stock market is reacting to the widening spreads in the CDS market. Experts have noted that the CDS market is thinly traded and that a few trades could have a disproportionate impact.

Matt Burnell, analyst at Wells Fargo securities, says the market may also be over-reacting to a "mis-reading of derivatives exposure."

Regulators recently published a report that said that Morgan Stanley is slated to have $1.78 trillion of outstanding notional value of derivatives at Morgan Stanley Bank N.A. at the end of the second quarter. But the report also said that after netting agreements, the actual credit exposure from its derivatives position totaled $457 million.

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