Credit Derivatives Handbook - Volume 1

BookmarkTitle:......Page 1
Chart 1: Beyond Single-Name CDS......Page 3
The Growth of Credit Derivatives......Page 4
Market Structure......Page 5
Chart 8: Credit Derivative Reference Entity By Maturity......Page 6
Chart 11: European Bond Market vs. London CDS Market......Page 7
Chart 12: Net Buyers [Sellers] of Protection by Sector......Page 8
Meeting the Challenges......Page 9
Table 4: The Two Parties in a Credit Default Swap......Page 11
A Working Example......Page 12
Table 5: Example Cashflows under fino defaultfl and Credit Event At 2 Years Scenarios......Page 13
The Asset Swap Approach to Pricing......Page 14
Table 6: Cash Flows of Default Swap Replication [Protection Seller]......Page 15
Chart 21: Cash Flows After Entering a Credit Default Swap Transaction......Page 16
Default Probability Models......Page 17
Chart 22: Default Swap Cashflows Due from the Buyer and Seller of Protection......Page 18
Chart 24: The CDSW Bloomberg Screen......Page 19
Chart 27: How Survival Probability Varies with Time for Different Recovery Assumptions [For a Given Default Premium]......Page 20
Chart 28: Assigning a CDS to a New Counterparty......Page 21
Chart 30: MTM Value Can Be Thought of In Terms of the Resulting Annuity......Page 22
Chart 31: Credit Event Terminates The Annuity Leaving An Investor Flat......Page 23
Table 8: Average Defaulted Bond Recovery Rates by Security and Priority, 1982-2005......Page 24
 Chart 34: Recovery Rates Differ by Sector......Page 25
Table 10: Example of an Existing Trade to be Unwound......Page 26
Chart 38: Difference in P&L Between the Two Transactions [Default Less Cash] for Simultaneous Spread Changes......Page 27
Chart 40: Incremental MTM Declines as Default Premiums Increase......Page 28
Chart 41: Cashflow Dynamics of Upfront and Running CDS......Page 29
Upfront or Running?......Page 31
Table 13: No Credit Event Cashflows for Protection Buyer Under a 5yr Basis Trade Scenario......Page 32
Table 14: Cashflows Under a 5yr Basis Trade Scenario Assuming Credit Event Immediately after Year 2......Page 33
Calculating an Upfront CDS Price......Page 34
Unwinding Upfront Trades......Page 35
Chart 45: Comparison in Performance of a Long Protection Position as Spreads Change: Upfront CDS vs. Running CDS......Page 36
Asset Swap Structures......Page 37
Chart 46: In a Par Structure the Package is Bought for 100 Irrespective of Bond Price......Page 38
Chart 48: Counterparty Risk for Par and Market ASW Structures......Page 39
Chart 49: I-Spread Illustration......Page 40
Z-Spread [Zero Volatility Spread]......Page 41
Table 16: Example of a Z-Spread Calculation - • 10yr 6% [Annual] Bond at 92 Cash Price......Page 42
Price Adjusted Z-Spread......Page 43
Chart 53: Using Bloomberg ASW Function to Value Asset Swaps and Z-Spreads......Page 44
Chart 56: CORUS Risky vs. Risk-free Discount Factor......Page 45
Table 17: Discounting CORUS 7 ½ 2011 Cashflows Using CDS Survival Curve......Page 46
Market Flows That Drive The Basis......Page 47
Chart 60: Fiat Default Swap Widened Sharply Following its Exchangeable Issue in 2001......Page 48
Chart 64: Commerzbank CDS Basis [Senior]......Page 49
Structural Basis Drivers......Page 50
Chart 67: Z-Spread to Call vs. CDS Premiums [ISYSLN]......Page 52
Chart 70: Using Equity Volatility & Basis for Relative Value in Cash vs Default Markets......Page 53
Chart 71: CDS Structural Roadmap......Page 54
Reference Entity......Page 55
Chart 72: Non-Sovereign Successor Summary Decision Tree......Page 56
Credit Events......Page 57
Obligations......Page 58
Protection Period......Page 59
Deliverable Obligations......Page 60
Table 20: Deliverable Obligation Characteristics and Usage......Page 61
Treatment of Guarantees......Page 62
Table 21: Summary of Restructuring Alternatives......Page 63
Chart 74: Restructuring Credit Event Options......Page 64
Chart 75: Summary of Restructuring Maturity Limitation Date under mod-R......Page 65
Case Studies: CDS and Acquisitions......Page 67
Chart 76: Acquisition Structure Favoring Protection Seller......Page 68
CDS Physical Settlement......Page 69
Table 24: Regional Settlement Convention Summary......Page 71
Chart 78: Summary of CDS Settlement Timeline......Page 72
Chart 79: The Major Global CDS Indices......Page 73
Table 26: iTraxx Indices [Europe, Asia and Australia]......Page 74
Chart 82: CDX.NA.IG.5 Entities by S&P Rating......Page 75
Table 27: Fixed Coupons......Page 76
Chart 86: CDX.NA.XO.5 vs. ML XOVR Sectors Representation......Page 77
Chart 88:  CDX.NA.HY.5 Entities by S&P Rating......Page 78
European Indices......Page 79
Chart 92: Ratings Breakdown......Page 80
Chart 94: iTraxx Crossover Index Members by Market Segment......Page 81
Chart 96: iTraxx Crossover Country Breakdown......Page 82
Pricing Convention......Page 83
Table 31: CDX.NA.HY.5 Bid/Offer......Page 84
Fair Value and the Index Skew......Page 85
Chart 104: On-the-Run CDX HY Quotes [Series 4 & 5] With and Without DPH......Page 86
Chart 106: fiCheap Shortfl - WOLKLU 7Y CDS......Page 88
Table 33: Selected Model-Implied Credit Shorts [Protection Buying Attractive] - CDS Tighter than Fair Value  Estimates......Page 89
Chart 110: Structure of a Typical CLN......Page 90
Curve Trades......Page 92
Chart 112: iTraxx Crossover Index 10-Year Curve Ratio......Page 93
Chart 113: Illustrative 3-Month P&L Profile of Position......Page 94
Chart 114: Kink vs Butterfly Carry [bps]......Page 95
Chart 115: FIAT Basis Trend November 2001 to June 2002......Page 96
Table 36: Illustration of P&L for a FIAT Flat Basis Trade......Page 97
Table 37: Loss Given Default for Bonds Relative to CDS......Page 99
Protected Bond Packages......Page 100
Chart 117: 1:1 Hedge......Page 101
Sub-Versus-Senior CDS Strategies......Page 102
Chart 123:Sub-Senior Spread Ratios [5Y] for iTraxx Financials Index [Banks & Insuers]......Page 103
Chart 124: Convertible Price vs Parity......Page 104
Table 40: Example Convertible Bond Hedge......Page 105
Debt-Equity Trades......Page 106
Chart 125: Illustrative Profit & Loss Diagram of a Theoretical Wings Trade......Page 107
Table 41: Illustrative Inputs for Wings Trade for Company XYZ......Page 108
Chart 127: 5-Year CDX.NA.IG and 1-Year S&P 500 ATM Implied Volatility [Weekly Data from Sep 7, 01 through Jan 4, 06]......Page 109
Chart 130: Average Stock Prices of S&P 500 Companies near Default [As of Jan 4, 06]......Page 110
Chart 131: Short CDS / Long Equity Put Candidates; per $100 credit notional;  Select Cases as of Jan 9, 06......Page 111
Protection Buyer......Page 112
CLN Structure Reduces Counterparty Risk......Page 113
Risk Reduction by Collateralisation......Page 114
Who Are The Counterparties?......Page 115
Novation & Systemic Risks......Page 116