Credit Derivatives

Credit Derivatives September 11, 2009 By A. V. Vedpuriswar

Historical perspective on credit derivatives ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Historical perspective on credit markets ,[object Object],[object Object],[object Object],[object Object],[object Object]

Innovations from Banker’s Trust (1) ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Innovations from Banker’s Trust (2) ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Innovations from Banker’s Trust (2) cont.. ,[object Object],[object Object],[object Object],[object Object]

The emergence of Credit Default Swaps ,[object Object],[object Object],[object Object],[object Object],[object Object]

What is a CDS? ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

CDS vs Insurance ,[object Object],[object Object],[object Object],[object Object],[object Object]

The Basics of CDS ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Who is the reference entity? ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Credit events ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

How much will be paid? ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Cheapest to deliver bond ,[object Object],[object Object],[object Object]

Dynamic Credit Default Swap ,[object Object],[object Object],[object Object]

Credit Intermediation Swap ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Basket Credit Default Swap ,[object Object],[object Object],[object Object],[object Object]

Constructing a Basket Credit Default Swap ,[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object]

Credit Indices ,[object Object],[object Object]

CDS Indexes ,[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object],[object Object]

Valuation of CDS ,[object Object],[object Object],[object Object],[object Object]

Related instruments ,[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object],Related instruments

Total return swap ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object]

Credit linked notes ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Credit spread option ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Credit (Spread) Option ,[object Object],[object Object],[object Object],[object Object],[object Object]

Collateralised Debt Obligations ,[object Object],[object Object],[object Object],[object Object]

Synthetic CDO ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object]

Solution ,[object Object],Year Default probability Survival probability Discount factor (e -rt ) PV of expected payment 1 .02 .98 .9512 .9322 s 2 .0196 .9604 .9048 .8690 s 3 .0192 .9412 .8607 .8101 s 4 .0188 .9224 .8187 .7552 s 5 .0184 .9040 .7788 .7040 s 4.0705 s

Solution Cont.. ,[object Object],Time (Years) Probability of default Expected pay off Discount factor PV of expected pay off 0.5 .0200 (.6) (.02) = .0120 .9753 .0117 1.5 .0196 (.6) (.0196) = .0118 .9277 .0109 2.5 .0192 (.6) (.0192) = .0115 .8825 .0102 3.5 .0188 (.6) (.0188) = .0113 .8395 .0095 4.5 .0184 (.6) (.0184) = .0111 .7985 .0088 .0511

Solution Cont.. ,[object Object],Time (Years) Probability of default Expected accrual payment Discount factor PV of expected accrual payment 1 .0200 .0100 s .9753 .0097 s 2 .0196 .0098 s .9277 .0091 s 3 .0192 .0096 s .8825 .0085 s 4 .0188 .0094 s .8395 .0079 s 5 .0184 .0092 s .7985 .0074 s .0426 s

Solution Cont.. ,[object Object],[object Object],[object Object],[object Object]

Solution ,[object Object],[object Object],[object Object],[object Object],Year Probability of default Survival probability e -(.06)t Present value 1 .03 .97 .9418 .9135 2 .0291 .9409 .8869 .8345 3 .0282 .9127 .8353 .7624 4 .0274 .8853 .7866 .6964 3.2068

Solution (Cont..) ,[object Object],[object Object],Year Probability of default e -(.06)t Present value 0.5 .03 .9705 .0291 1.5 .0291 .9139 .0266 2.5 .0282 .8607 .0243 3.5 .0274 .8106 .02221 .1022

Solution (Cont..) ,[object Object],[object Object],[object Object],[object Object],[object Object],Year Probability of default e -(.06)t Present value 0.5 .03 .9705 .0291 1.5 .0291 .9139 .0266 2.5 .0282 .8607 .0243 3.5 .0274 .8106 .02221 .1022

Credit Derivatives

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Credit Derivatives