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12.2 cds indices
- 1. Copyright © 2018 CapitaLogic Limited
Chapter 12
Credit Indices
This presentation file is prepared in accordance with
Chapter 12 of the text book
“Managing Credit Risk Under The Basel III Framework, 3rd ed”
Website : https://sites.google.com/site/crmbasel
E-mail : crmbasel@gmail.com
- 2. Copyright © 2018 CapitaLogic Limited 2
Declaration
Copyright © 2018 CapitaLogic Limited.
All rights reserved. No part of this presentation file may be
reproduced, in any form or by any means, without written
permission from CapitaLogic Limited.
Authored by Dr. LAM Yat-fai (林日辉),
Director, CapitaLogic Limited,
Adjunct Professor of Finance, City University of Hong Kong,
Doctor of Business Administration,
CFA, CAIA, CAMS, FRM, PRM.
- 3. Copyright © 2018 CapitaLogic Limited 3
Outline
CDS indice
CDS index contract
- 4. Copyright © 2018 CapitaLogic Limited 4
CDS index
The arithmetic average of the CDS spreads of a group of
liquidly traded and standardized single name CDSs (from 3 to
125)
Originated on specific days in March and September
After the origination day, the CDS spreads are calculated by
setting the value of the component single name CDSs to zero
A metric to represent the systematic credit quality of a
specific market segment
N
k
k=1
CDS spread
CDS index =
N
- 5. Copyright © 2018 CapitaLogic Limited 5
CDS index
Operated and published by Mark-it
CDX family of indices for North America and
emerging markets
iTraxx family of indices for Europe and Asia
http://www.markit.com/markit.jsp?jsppage=in
dices.jsp
- 6. Copyright © 2018 CapitaLogic Limited 6
Classification
Geographic area
CDX index
North America
Emerging market
iTraxx
Europe
Asia
Type of debt issuers
Corporation
Government
Credit quality
Investment grade
High yield grade
Crossover
Standard tenor
1, 2, 3, 5, 7, 10 years
- 7. Copyright © 2018 CapitaLogic Limited 7
CDX indices
Region Credit quality/theme No. of CDS s Index
North
America
Investment grade 125 CDX.NA.IG
Investment grade and high volatility 30 CDX.NA.IG.HVOL
High yield grade 100 CDX.NA.HY
BB 37 CDX.NA.HY.BB
B 46 CDX.NA.HY.B
Crossover 35 CDX.NA.XO
First lien leveraged loans 100 LCDX
Emerging
markets
14 CDX.EM
Diversified 40 CDX.EM Diversified
- 8. Copyright © 2018 CapitaLogic Limited 8
iTraxx indices (1)
Region Theme No. of CDSs Index
Europe 125 iTraxx Europe
High volatility 30 iTraxx Europe HiVol
Crossover 75 iTraxx Europe Crossover
First lien loan 40 iTraxx LEVX
Non-financial 100 iTraxx Non-Financials
Senior subordination financial 25 iTraxx Financials Senior
Junior subordination financial 25 iTraxx Financials Sub
Telecommunications, media
and technology
20 iTraxx TMT
Industrial 20 iTraxx Industrials
Energy industry 20 iTraxx Energy
Manufacturers of consumer products 30 iTraxx Consumers
Automobile industry 10 iTraxx Autos
- 9. Copyright © 2018 CapitaLogic Limited 9
iTraxx indices (2)
Region Theme No. of CDSs Index
Asia
Ex-Japan investment grade 50 iTraxx Asia
Ex-Japan high yield 20 iTraxx Asia HY
Japan 50 iTraxx Japan
Australia 25 iTraxx Australia
Country
West Europe 15 iTraxx SOVX West Europe
Central/East Europe, Middle East
and Africa
15 iTraxx SOVX CEEMEA
Asia Pacific 10 iTraxx SOVX Asia Pacific
Latin America 8 iTraxx SOVX Latin America
Global liquid investment grade iTraxx SOVX IG
G7 iTraxx SOVX G7
Brazil, Russia, India, China iTraxx SOVX BRIC
Example 12.1
- 10. Copyright © 2018 CapitaLogic Limited 10
CDS index series
On-the-run series
Standard tenor + 3 months to standard tenor - 3 months
New series once every six months in March and
September
New group of component single name CDSs proposed by
CDS traders
Off-the-run series
Protection period < Standard tenor - 3 months
Very low market attention
- 11. Copyright © 2018 CapitaLogic Limited 11
Survival revision to CDS index
Initial CDS index
Revised CDS index
Initial no. of reference debts
k
k=1
No. of survival debts
k
k=1
CDS spread
Initial no. of reference debts
CDS spread
No. of survival reference debts
- 12. Copyright © 2018 CapitaLogic Limited 12
Not a consistent tool
for monitoring of credit market
Default effect
CDS index
increases sharply before the default of a reference debt
decreases sharply after the default of a reference debt
Discontinuity
Abrupt jump on the effective day of a new on-
the-run series
Selection bias
Understate the trend of deterioration or
improvement
- 13. Copyright © 2018 CapitaLogic Limited 13
Outline
CDS index
CDS index contract
- 14. Copyright © 2018 CapitaLogic Limited 14
CDS index contract
A portfolio of single name CDSs
Reference debts = Components in a CDS
index
CDS principal = Contractual principal / N
Standardized premium rate
100 bps per quarter for investment grade index
500 bps per quarter for high yield grade index
Contract value = Sum of CDS values
- 15. Copyright © 2018 CapitaLogic Limited 15
Functional purpose
Most liquidly traded credit instrument
Trading on the systematic credit quality
Low value when systematic credit quality is high
High value when systematic credit quality is low
Long a CDS index contract when an investor expects
the systematic credit quality to deteriorate
Short a CDS index contract when an investor
expects the systematic credit quality to improve
- 16. Copyright © 2018 CapitaLogic Limited 16
Upfront payments
Upfront fee
Protection buyer to protection seller when
the present value of expected protection is
higher than that of expected premiums
Protection seller to protection buyer when
the present value of expected protection is
lower than that of expected premiums
- 17. Copyright © 2018 CapitaLogic Limited 17
Premiums
Standard premium
Quarterly
Accrued premium
Accrued premium of the defaulted reference debt
Reduced premium
Standard premium
Number of survival reference debts
×
Initial no. of reference debts
- 18. Copyright © 2018 CapitaLogic Limited 18
Cash settlement
Upon default of a reference debt
Contractual principal
× LGD of defaulted debt
Payoff =
Initial number of reference debts
- 19. Copyright © 2018 CapitaLogic Limited 19
Valuation
Category Factor Impact to value
(long position)
Variation after
origination
Impact to
credit risk
(short position)
Reference
debt
Contractual principal + No +
LGD + Moderate +
PD + Material +
Protection period +
Decreasing
gradually
+
Portfolio
Concentration of
debts
+
Default dependency +
CDS index Premium rate - No
- 20. Copyright © 2018 CapitaLogic Limited 20
Credit risk
Long position
No credit risk
Short position
XCL as a valid credit risk measure for a CDS
index contract with sufficiently large no. of
reference debts (e.g. > 30)