The party line for value investors is that a falling market is great because it provides the opportunity to pick up companies at really low prices. While I'm not convinced that most investors really believe this in their hearts, it can actually be true. Look at the lows of the last bear market. You could have picked up (NASDAQ:AMZN) in the single digits in 2001 and had a 300% return in a couple years. And Yahoo! (NASDAQ:YHOO) was even better. You could have grabbed that one for $5 back then, and sold it for more than $30 at nearly any time in the past year.

In the spirit of the current choppy market, I went looking for bargains, and I found a bunch. They range from dominant, growing large caps priced like they're three years past expiry to small, high-growth companies trading at prices totally disconnected from their real potential. One of the most intriguing in the latter group is Primus Guaranty (NYSE:PRS). Analysts think this company will grow at a 25% rate over the next five years, yet it's selling at a price-to-earnings ratio (P/E) of less than nine.

The business
Primus' main business is selling credit default swaps (CDS), which act as insurance against a company going bankrupt. Suppose I own $25 million of bonds of innovative food-wrapping company Uranium Foil Ltd. I'm worried about the health of the business, so I pay a quarterly premium to buy a CDS from Primus. In return, should litigious consumers drive Uranium Foil into bankruptcy in the next five years, Primus will pay me $25 million in exchange for my near-worthless bonds.

Of course, Primus wants to take in high premiums, but minimize the chance of paying out the $25 million when a company goes under. So Primus' goal is to evaluate the risk of companies blowing up, and price their credit default swaps based on the difference between the premiums and the risk of default. Generally, these contracts are five years in length, which is important. Other insurers like AIG (NYSE:AIG) and St. Paul Travelers (NYSE:STA) are facing asbestos claims decades after the exposure occurred. Primus, on the other hand, only has to worry about its analysis being accurate for five years.

Competitive position
The CDS market is a multitrillion-dollar face-value market, growing at high-double-digit rates. Though Primus has a AAA counterparty credit rating from Standard & Poor's, it's a relatively small player. Historically, the market's biggest participants have been huge banks like JPMorgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC) that want to hedge their investments. Obviously, Primus has fewer resources than such companies, but Primus' small size can sometimes be an advantage, too. It allows Primus to be selective about the opportunities it pursues, but also means that the company can potentially grow at a high rate for a long time without the size of the market becoming a limiting factor.

That said, while the market offers significant barriers to entry against the average Joe, there's little preventing anyone with experience and connections in the area from setting up a competitive business. Over the long term, Primus' main competitive advantages will likely be its connections within the industry, its trading platforms, the accuracy of its credit models, and its discipline in only writing profitable business. But while management has extensive experience in the credit derivatives markets, the company itself has only been around for a few years, so it's difficult for an outsider to be particularly confident of the strength of any of these potential competitive advantages to Primus at this point.

The downside
Primus has a host of potential risks. First, it's such a new company (incorporated in 1998, IPO'd in 2004) that it hasn't even been through a full business cycle, so there's no guarantee that it's pricing the risk correctly. Even if it is, there's no way to be sure that Primus' risk model is robust enough to handle unusual events where multiple companies go under simultaneously, as might happen if several insurance companies get pounded by a bad hurricane season or a terrorist attack. If such an event were to weaken Primus enough to hurt its credit rating, potential counterparties could choose to avoid doing business with Primus. Or the company could be forced to sell equity to maintain its credit rating. Either scenario spells pain for shareholders.

Even if Primus does model risk correctly, there's a chance of a derivative-market blowup. All of the players in the derivative market are closely intertwined. If a major player were to implode, the resulting ripples could drive a number of players under, and it's impossible to predict the fallout from such an event until it actually happens. The best Primus can do is minimize exposure to any one industry and diversify across a number of different counterparties, and the company has done so. It's most exposed to the insurance industry, which makes up roughly 8% of its portfolio. Primus does business with 42 different counterparties; roughly half of that business is with the top five counterparties.

American investors should be aware of one additional complication: The company is based in Bermuda, and since Primus derives its income from investments, it qualifies as a passive foreign investment company (PFIC). Such investments have certain special negative tax implications that can impact your return, so all investors considering Primus should examine the tax issues carefully before purchasing shares.

So why consider buying a company with indeterminate competitive advantages and some small but real chance of blowing up in any given year? Well, because it's dirt cheap. If you use the Motley FoolInside Valuediscounted cash flow calculator with a 15% discount rate, 20% growth in the first five years, followed by 12% growth for the next five, followed by terminal growth of 3% annually, the company is worth $20 to $25 -- way more than its current $10 price tag. And these aren't particularly aggressive assumptions. After 10 years, Primus will still be earning less than $250 million a year -- a relatively small amount that leaves room for continued growth.

But while it's way undervalued, Primus isn't a stock for your grandmother. While the ratio of risk to reward seems to favor investors, there is some chance that a catastrophic event could bring the company down. And as I said before, right now, there are some great and equally undervalued companies out there with less risk. Primus is cheap, but far from the only option. Our Inside Value newsletter has detailed analysis of some of the best of these other undervalued companies. You can read about all of our recommendations with a one-month free trial here.

Fool contributor Richard Gibbons wishes that he could purchase credit default swaps on certain of his friends. He does not have a position in any security discussed in this article. Bank of America and JPMorgan Chase are Income Investor recommendations. is a Stock Advisor recommendation. The Fool has adisclosure policy.