How to Make $1.7 Billion in One Year

Updated from 8:41 a.m. EDT

John Paulson made so many smart bets in 2007, one of the most-difficult years for this market that we've seen in some time, that he made $1.7 billion for himself for the year. No hedge fund was more successful in 2007 than Paulson's, which was up a whopping 435% for the year. Halfway through 2008, Paulson & Co. is striking again, up 26%, vs. -15% for the S&P 500.

Formed by John Paulson of Queens, N.Y., ironically a former Bear Stearns banker, the fund bet that the subprime market would collapse in 2007 and throughout 2008. Paulson & Co.'s primary method was to buy credit default swaps, commonly known as CDS's, on various financial institutions and indexes.

With credit easily available and the housing market still enacted, credit default swaps on money center banks and homebuilders were trading for almost nothing. By all accounts, Paulson was risking 3% to 5% of his entire portfolio by buying these credit default swaps, with the possibility of making 10 times to 40 times his entire portfolio if things got really nasty. ...