Mastering Credit Derivatives: a step-by-step guide to credit derivatives and structured credit

Cover......Page 1
Mastering Credit Derivatives......Page 2
About the author......Page 6
Contents......Page 8
Preface......Page 12
Publisher’s acknowledgements......Page 15
Introduction......Page 16
 What’s in a name?......Page 17
 How big is the market?......Page 18
 Who is involved?......Page 21
 Evolution of the market......Page 25
Credit derivative instruments and applications......Page 28
 Credit derivatives products......Page 29
 Trades using credit derivatives......Page 35
 Risk measures for CDS......Page 38
 Comparing bond spreads and CDS prices......Page 39
 Basket default swaps......Page 44
 Synthetic CDOs......Page 50
 Summary: application of credit derivatives......Page 56
Pricing a CDS and the cash bond basis......Page 58
 Credit modelling......Page 59
 Calibrating recovery rates......Page 62
 A practical approach to pricing a CDS......Page 64
 Using default swaps to make a credit curve......Page 70
 Linking the credit default swap and cash markets......Page 71
 Cash and CDS basis......Page 75
 Bond spread measures and the CDS–bond basis definition......Page 78
 Basis drivers......Page 82
 Summary: credit default swaps compared with bonds......Page 89
Credit derivatives documentation and regulations......Page 94
 Documentation......Page 95
 Infrastructure and ISDA’s role......Page 96
 Restructuring: the 2003 definitions......Page 98
 Other Considerations......Page 102
 Bank regulation of credit derivatives......Page 104
Tranched indices......Page 112
 Credit default swap indices......Page 113
 Impact of defaults on index cashflows......Page 118
 Tranches of standard default swap indices......Page 119
 Characteristics of benchmark tranches......Page 120
 Investment strategies with credit derivative indices......Page 123
 Investors......Page 127
What is correlation?......Page 128
 What do we mean by correlation?......Page 129
 Correlation in structured credit markets......Page 130
 Observing default correlation......Page 132
 Valuation in structured credit markets......Page 135
 Getting to a portfolio loss distribution......Page 136
 Copula functions......Page 137
 Correlation as a relative value metric (base correlation)......Page 138
 Base correlation......Page 140
 Practical use of correlation......Page 141
 Modelling correlated defaults......Page 144
 Simulating correlated defaults with a copula......Page 146
 What is correlation missing?......Page 151
 A summary of CDO pricing......Page 152
 Copula drawbacks......Page 153
First-to-default (FTD) baskets......Page 156
 Basket default swap mechanics......Page 157
 Investor motivation......Page 159
 Mergers and FTD baskets......Page 161
 Second-through-fifth default baskets......Page 163
 Funded baskets......Page 164
Cash CDOs......Page 166
 Assets, tranches, purposes and credit structures......Page 168
 The à la carte CDO menu......Page 172
 How do cash CDOs work in practice?......Page 175
 Cash CDOs: a taxonomy......Page 180
 Structural features and performance tests in cash CDOs......Page 182
 Understanding CDO debt returns......Page 189
 Details of a cash CDOs structure......Page 190
Synthetic CDOs......Page 194
 What are synthetic CDOs?......Page 195
 Example of a fully unfunded synthetic CDO......Page 200
 Example of an AAA reference portfolio CDO......Page 202
 Case studies of managed synthetic CDOs or CSOs......Page 203
 Single-tranche CDOs (STCDOs)......Page 205
 CSO trade opportunities......Page 215
 Synthetic CDO structures......Page 216
 Analytical challenges in modelling synthetic CDOs......Page 224
 The ABCs of CDOs-squared......Page 226
Understanding tranche sensitivity......Page 230
 Tranches as options on default......Page 232
 Sensitivity to spread changes (‘delta’)......Page 233
 ‘I – Gamma’: sensitivity to spread distribution changes......Page 234
 Delta migration......Page 236
 ‘M – Gamma’: convexity......Page 239
 Jump-to-default sensitivity......Page 241
 ‘Theta’: time decay......Page 243
 ‘Rho’: sensitivity to correlation changes......Page 244
 Conclusion......Page 247
Innovation, the credit crisis and the future......Page 248
 Subprime mortgage crisis of 2007......Page 249
 Credit crisis events in context......Page 259
 Subprime credit crunch: a summmary......Page 266
 Subprime and credit crunch debate......Page 267
 How regulators and banks improve risk management......Page 272
Notes and references......Page 274
Glossary......Page 278
Index......Page 284