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Understanding Credit Derivatives and Related Instruments
1st Edition - December 6, 2004
Author: Antulio N. Bomfim
Language: English
Hardback ISBN:9780121082659
9 7 8 - 0 - 1 2 - 1 0 8 2 6 5 - 9
eBook ISBN:9780080481487
9 7 8 - 0 - 0 8 - 0 4 8 1 4 8 - 7
The global credit derivatives market is estimated to have grown from virtually nothing in the early 1990s to over $2 trillion dollars. Although still relatively young, the credit…Read more
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The global credit derivatives market is estimated to have grown from virtually nothing in the early 1990s to over $2 trillion dollars. Although still relatively young, the credit derivatives market has already developed to the point where one can characterize its evolution in terms of developments in its various segments, such as the market for single-name credit derivatives or the market for credit derivatives written on sovereign credits.
Understanding Credit Derivatives offers a comprehensive introduction to the credit derivatives market. Rather than presenting a highly technical exploration of the subject, it offers intuitive and rigorous summaries of the major subjects and the principal perspectives associated with them. The centerpiece is pricing and valuation issues, especially discussions of different valuation tools and their use in credit models.
* Offers a broad overview of this growing field * Discusses all the main types of credit derivatives * Provides back-of-the-book summary of statistics and fixed-income mathematics
Graduate Students in MBA and specialized finance programs, professionals working with investment tool such as financial analysts and portfolio managers.
Part I Credit Derivatives: Definition, Market, Uses
1 Credit Derivatives: A Brief Overview 1.1 What are Credit Derivatives? 1.2 Potential \Gains from Trade"" 1.3 Types of Credit Derivatives 1.3.1 Single-Name Instruments 1.3.2 Multi-Name Instruments 1.3.3 Credit-Linked Notes 1.3.4 Sovereign vs. Other Reference Entities 1.4 Valuation Principles 1.4.1 Fundamental Factors 1.4.2 Other Potential Risk Factors 1.4.3 Static Replication vs. Modeling 1.4.4 A Note on Supply, Demand, and Market Frictions 1.5 Counterparty Credit Risk (Again)
2 The Credit Derivatives Market 2.1 Evolution and Size of the Market 2.2 Market Activity and Size by Instrument Type 2.2.1 Single- vs. Multi-name Instruments 2.2.2 Sovereign vs. Other Reference Entities 2.2.3 Credit Quality of Reference Entities 2.2.4 Maturities of Most Commonly Negotiated Contracts 2.3 Main Market Participants 2.3.1 Buyers and Sellers of Credit Protection 2.4 Common Market Practices 2.4.1 A First Look at Documentation Issues 2.4.2 Collateralization and Netting 3 Main Uses of Credit Derivatives 3.1 Credit Risk Management by Banks 3.2 Managing Bank Regulatory Capital 3.2.1 A Brief Digression: The 1988 Basle Accord 3.2.2 Credit Derivatives and Regulatory Capital Management 3.3 Yield Enhancement, Portfolio Diversi_cation 3.3.1 Leveraging Credit Exposure, Unfunded Instruments 3.3.2 Synthesizing Long Positions in Corporate Debt 3.4 Shorting Corporate Bonds 3.5 Other uses of credit derivatives 3.5.1 Hedging Vendor-_nanced Deals 3.5.2 Hedging by convertible bond investors 3.5.3 Selling Protection as an Alternative to Loan Origination 3.6 Credit Derivatives as Market Indicators
Part II Main Types of Credit Derivatives 4 Floating-Rate Notes 4.1 Not a Credit Derivative 4.2 How Does It Work? 4.3 Common Uses 4.4 Valuation Considerations 5 Asset Swaps 5.1 A Borderline Credit Derivative 5.2 How Does It Work? 5.3 Common Uses 5.4 Valuation Considerations 5.4.1 Valuing the two pieces of an asset swap 5.4.2 Comparison to Par Floaters 6 Credit Default Swaps 6.1 How Does It Work? 6.2 Common Uses 6.2.1 Protection Buyers 6.2.2 Protection Sellers 6.2.3 Some Additional Examples 6.3 Valuation Considerations 6.3.1 CDS vs. Cash Spreads in Practice 6.3.2 A Closer Look at the CDS-Cash Basis 6.3.3 When Cash Spreads are Unavailable 6.4 Variations on the Basic Structure 7 Total Return Swaps 7.1 How Does It Work? 7.2 Common Uses 7.3 Valuation Considerations 7.4 Variations on the Basic Structure 8 Spread and Bond Options 8.1 How Does It Work? 8.2 Common Uses 8.3 Valuation Considerations 8.4 Variations on Basic Structures 9 Basket Default Swaps 9.1 How Does It Work? 9.2 Common Uses 9.3 Valuation Considerations 9.3.1 A first look at default correlation 9.4 Variations on the Basic Structure 10 Portfolio Default Swaps 129 10.1 How Does It Work? 10.2 Common Uses 10.3 Valuation Considerations 10.3.1 A _rst look at the loss distribution function 10.3.2 Loss distribution and default correlation 10.4 Variations on the Basic Structure 11 Principal-Protected Structures 11.1 How Does It Work? 11.2 Common Uses 11.3 Valuation Considerations 11.4 Variations on the Basic Structure 12 Credit-Linked Notes 12.1 How Does It Work? 12.2 Common Uses 12.3 Valuation Considerations 12.4 Variations on the Basic Structure 13 Repackaging Vehicles 13.1 How Does It Work? 13.2 Why Use Repackaging Vehicles? 13.3 Valuation Considerations 13.4 Variations on the Basic Structure 14 Synthetic CDOs 161 14.1 Traditional CDOs 14.1.1 How Does it Work? 14.1.2 Common Uses 14.1.3 Valuation Considerations 14.2 Synthetic Securitization 14.2.1 Common uses: Why go synthetic? 14.2.2 Valuation considerations for synthetic CDOs 14.2.3 Variations on the Basic Structure III Introduction to Credit Modeling I: Single-Name Defaults 15 Valuing Defaultable Bonds 15.1 Zero-coupon Bonds 15.2 Risk-neutral Valuation and Probability 15.2.1 Risk-neutral probabilities 15.3 Coupon-paying Bonds 15.4 Nonzero Recovery 15.5 Risky Bond Spreads 15.6 Recovery Rates 16 The Credit Curve 16.1 CDS-implied Credit Curves 16.1.1 Implied Survival Probabilities 16.1.2 Examples 16.1.3 Flat CDS Curve Assumption 16.1.4 A Simple Rule of Thumb 16.1.5 Sensitivity to Recovery Rate Assumptions 16.2 Marking to Market a CDS Position 16.3 Valuing a Principal-protected Note 16.3.1 Examples 16.3.2 PPNs vs. Vanilla Notes 16.4 Other Applications and Some Caveats 17 Main Credit Modeling Approaches 17.1 Structural Approach 17.1.1 The Black-Scholes-Merton Model 17.1.2 Solving the Black-Scholes-Merton Model 17.1.3 Practical Implementation of the Model 17.1.4 Extensions and Empirical Validation 17.1.5 Credit Default Swap Valuation 17.2 Reduced-Form Approach 17.2.1 Overview of Some Important Concepts 17.2.1.1 Stochastic interest rates 17.2.1.2 Forward default probabilities 17.2.1.3 Forward default rates 17.2.2 Uncertain Time of Default 17.2.3 Default Intensity 17.2.4 Pricing Defaultable Bonds 17.2.4.1 Non-zero recovery 17.2.4.2 Alternative recovery assumptions 17.2.5 Extensions and Uses of Reduced-form Models 17.2.6 Credit Default Swap Valuation 17.3 Comparing the Two Main Approaches 17.4 Ratings-based Models 18 Valuing of Credit Options 18.1 Forward-starting contracts 18.1.1 Valuing a Forward-starting CDS 18.1.2 Other forward-starting structures 18.2 Valuing Credit Default Swaptions 18.3 Valuing other Credit Options 18.4 Alternative Valuation Approaches 18.5 Valuing Bond Options IV Introduction to Credit Modeling II: Portfolio Credit Risk 19 The Basics of Portfolio Credit Risk 19.1 Default Correlation 19.1.1 Pairwise default correlation 19.1.2 Modeling default correlation 19.1.3 Pairwise default correlation and \_"" 19.2 The Loss Distribution Function 19.2.1 Conditional loss distribution function 19.2.2 Unconditional loss distribution function 19.2.3 Large-portfolio approximation 19.3 Default Correlation and Loss Distribution 19.4 Monte Carlo Simulation: Brief Overview 19.4.1 How Accurate is the Simulation-Based Method? 19.4.2 Evaluating the Large-Portfolio Method 19.5 Conditional vs. Unconditional Loss Distributions 19.6 Other Approaches to Portfolio Credit Risk Modeling 20 Valuing Basket Default Swaps 20.1 Basic Features of Basket Swaps 20.2 Reexamining the Two-Asset FTD Basket 20.3 FTD Basket with Several Reference Entities 20.3.1 A simple numerical example 20.3.2 A more realistic valuation exercise 20.4 The Second-to-Default Basket 20.5 Basket Valuation and Asset Correlation 20.6 Extensions and Alternative Approaches 21 Valuing Portfolio Swaps and CDOs 21.1 A Simple Numerical Example 21.2 Model-based Valuation Exercise 21.3 The E_ects of Asset Correlation 21.4 The Large-Portfolio Approximation 21.5 Valuing CDOs: Some basic insights 21.5.1 Special considerations for CDO valuation 21.6 Concluding Remarks 22 A Quick Tour of Commercial Models 22.1 CreditMetrics 22.2 The KMV Framework 22.3 CreditRisk+ 22.4 Moody’s Binomial Expansion Technique 22.5 Intensity-based Models 22.6 Concluding Thoughts 23 Modeling Counterparty Credit Risk 23.1 The Single-Name CDS as a \Two-Asset Portfolio"" 23.2 The Basic Model 23.3 A CDS with No Counterparty Credit Risk 23.4 A CDS with Counterparty Credit Risk 23.4.1 Analytical derivation of joint probabilities of default 23.4.2 Simulation-based approach 23.4.3 An Example 23.5 Other Models and Approaches 23.6 Counterparty Credit Risk in Multiname Structures V A Brief Overview of Documentation and Regulatory Issues 24 Anatomy of a CDS Transaction 24.1 Standardization of CDS Documentation 24.1.1 Essential terms of a CDS transaction 24.1.1.1 The reference entity 24.1.1.2 Reference and deliverable obligations 24.1.1.3 Settlement method 24.1.1.4 Credit events 24.1.2 Other important details of a CDS transaction 24.2 When a Credit Event Takes Place 24.2.1 Credit event noti_cation and veri_cation 24.2.2 Settling the contract 24.3 The Restructuring Debate 24.3.1 A case in point: Conseco 24.3.2 Modi_ed Restructuring 24.3.3 A Bifurcated Market 24.4 Valuing the Restructuring Clause 24.4.1 Implications for implied survival probabilities 25 A Primer on Bank Regulatory Issues 25.1 The Basel II Capital Accord 25.2 Basel II Risk Weights and Credit Derivatives 25.3 Suggestions for Further Reading Appendix A Basic Concepts from Bond Math A.1 Zero-coupon Bonds A.2 Compounding A.3 Zero-coupon Bond Prices as Discount Factors A.4 Coupon-paying Bonds A.5 Inferring Zero-coupon Yields from the Coupon Curve A.6 Forward Rates A.7 Forward Interest Rates and Bond Prices Appendix B Basic Concepts from Statistics B.1 Probability Density Function: Discrete Case B.2 Cumulative Distribution Function B.3 Probability Density Function: Continuous Case B.4 Expected Value and Variance B.5 Bernoulli Trials and the Bernoulli Distribution B.6 The Binomial Distribution B.7 The Poisson and Exponential Distributions B.8 The Normal Distribution B.9 The Lognormal Distribution B.10 Joint Probability Distributions B.11 Independence B.12 The Bivariate Normal Distribution
No. of pages: 368
Language: English
Edition: 1
Published: December 6, 2004
Imprint: Academic Press
Hardback ISBN: 9780121082659
eBook ISBN: 9780080481487
AB
Antulio N. Bomfim
Antulio N. Bomfim Senior Managing Director and Co-Head of Monetary Policy Insights at Macroeconomic Advisers, LLC. He received his M.A. and Ph.D. in
Economics at the University of Maryland and his M.Sc.in Mathematical Finance at the University of Oxford.
Affiliations and expertise
Macroeconomic Advisers, LLC, Washington, DC, USA
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