Book Categories

Description of Credit Derivatives

The credit derivatives market has developed rapidly over the last ten years and is now well established in the banking community and is increasingly making its presence felt in all areas of finance. This book covers the subject from credit bonds, asset swaps and related ‘real world’ issues such as liquidity, poor data, and credit spreads, to the latest innovations in portfolio products, hedging and risk management techniques. The book concentrates on practical issues and develops an understanding of the products through applications and detailed analysis of the risks and alternative means of trading. Credit Derivatives: Risk Management, Trading and Investing provides:

• A description of the key products, applications, and an analysis of typical trades including basis trading, hedging, and credit structuring
  
  
• Analysis of the industry standard ‘default and recovery’ and Copula models including many examples, and a description of the models’ shortcomings
  
  
• Tools and techniques for the management of a portfolio or book of credit risks including appropriate and inappropriate methods of correlation risk management
  
  
• A thorough analysis of counterparty risk
  
  
• An intuitive understanding of credit correlation in reality and in the Copula model
  

The book also includes many spreadsheet examples, a dll for the pricing of CDO structures, and code in MathCad covering a variety of applications.

Title Information

ISBN:

9780470024164

Pages:

336 pages

Format:

Hardback

Product Code:

21048

Publisher:

John Wiley & Sons Ltd

Published:

20/05/2005

Edition:

illustrated edition

Write a review of this book

Customer Reviews from Amazon

About Geoff Chaplin

GEOFF CHAPLIN studied mathematics at Cambridge (MA 1972) and Oxford (MSc 1973, DPhil 1975) and qualified as an actuary (FFA 1978) while working in a life insurance company. He moved to the City in 1980 and has worked for major banks (including HSBC, Nomura International, and ABN AMRO) as well as consulting to hedge funds, corporate treasurers, and institutional investment funds. He has been involved in the credit derivatives market since 1996 and has both traded portfolio products and developed risk management systems for these products. In addition to consulting and training for the major financial institutions, Geoff has maintained strong academic interests and was a visiting (emeritus) professor at the University of Waterloo (Canada) from 1987 until 1999. He has also published many articles (in Risk, the Journal of the Institute and Faculty of Actuaries, and others) and speaks regularly at conferences on credit derivatives.

Contents of Credit Derivatives

Preface
Acknowledgements
Disclaimer and Software Instructions
Table of Spreadsheet Examples and Software


PART I. CREDIT BACKGROUND AND CREDIT DERIVATIVES

1. Credit Debt and Other Traditional Credit Instruments
1.1 Bonds and loans; LIBOR rates and swaps; 'repo' and general collateral rates
1.1.1 Bonds and loans
1.1.2 BBA LIBOR and swaps
1.1.3 Collateralised lending and repo
1.1.4 Repo as a credit derivative
1.2 Credit debt versus 'risk-free' debt
1.3 Issue documents, seniority and the recovery process
1.3.1 Issue documents and default
1.3.2 Claim amount
1.3.3 The recovery process and recovery amount
1.3.4 Sovereign versus corporate debt
1.4 Valuation, yield and spread
1.5 Buying risk
1.6 Marking to market, marking to model and reserves

2. Default and Recovery Data; Transition Matrices; Historical Pricing
2.1 Recovery: ultimate and market value based recovery
2.1.1 Ultimate recovery
2.1.2 Market recovery
2.1.3 Recovery rates and industry sector
2.1.4 Recovery and default rates and the economic cycle
2.1.5 Modelling recovery rates
2.2 Default rates: rating and other factors
2.3 Transition matrices
2.4 Measures' and transition matrix-based pricing
2.5 Spread jumps and spread volatility derived from transition matrices
2.6 Adjusting transition matrices

3. Asset Swaps and Asset Swap Spread; z-Spread
3.1 'Par-par' asset swap contracts
3.1.1 Contract description and hedging
3.1.2 Hedging
3.1.3 Default of the reference name
3.2 Asset swap spread
3.3 Maturity and z-spread
3.4 Callable asset swaps; 'perfect' asset swaps
3.4.1 Callable asset swaps
3.4.2 'Perfect' asset swaps
3.5 A bond spread model

4. Liquidity, the Credit Pyramid and Market Data
4.1 Bond liquidity
4.2 The Credit Pyramid
4.3 Survey and engineered spread data
4.3.1 Survey data
4.3.2 Engineered data
4.4 Spread and rating

5. Traditional Counterparty Risk Management
5.1 Vetting
5.2 Collateralisation and netting
5.3 Additional counterparty requirements for credit derivative counterparties
5.4 Internal capital charge

6. Credit Portfolios and Portfolio Risk
6.1 VaR and counterpartyVaR
6.2 Distribution of forward values of a credit bond
6.3 Correlation and the multi-factor Normal (Gaussian) distribution
6.4 Correlation and the correlation matrix

7. Introduction to Credit Derivatives
7.1 Products and users
7.1.1 'Traditional' credit instruments
7.1.2 'Single name' credit derivatives
7.1.3 Credit-linked notes
7.1.4 Portfolio credit derivatives
7.2 Market participants and market growth


PART II. CREDIT DEFAULT SWAPS AND OTHER SINGLE NAME PRODUCTS

8. Credit Default Swaps; Product Description and Simple Applications
8.1 CDS product definition
8.1.1 Contract description and example
8.1.2 Market CDS quotes
8.1.3 Related products
8.2 Documentation
8.2.1 ISDA documentation and insurance contract differences
8.2.2 Reference obligations and 'Mark-it RED'
8.3 Credit triggers for credit derivatives
8.3.1 Credit events
8.3.2 Restructuring
8.4 CDS Applications and elementary strategies
8.4.1 Single names
8.4.2 Sector/portfolio trades
8.4.3 Income generation
8.4.4 Regulatory capital reduction
8.5 Counterparty risk: PFE for CDS
8.6 CDS trading desk
8.6.1 Mechanics of transacting a CDS deal
8.6.2 Trade monitoring, credit events, unwinds
8.6.3 CDS desk interactions and organisation
Addendum: ISDA 2003 CDS confirmation

9. Valuation and Risk: Basic Concepts and the Default and Recovery Model
9.1 The fundamental credit arbitrage: repo cost
9.2 Default and recovery model; claim amount
9.2.1 Claim amount
9.2.2 Recovery modelling
9.2.3 Hazard (default) rate model
9.2.4 Choice of hazard rate function/interpolation process
9.3 Deterministic default rate model
9.3.1 CDS valuation
9.3.2 Accrued interest and the delivery option
9.3.3 CDS under constant hazard rate
9.3.4 Bond valuation
9.3.5 Bond price under a constant hazard rate
9.3.6 Limiting cases of the bond price
9.3.7 Risky zero coupon bonds
9.3.8 CDS and bond sensitivities
9.4 Stochastic default rate model; hazard and pseudo-hazard rates
9.5 Calibration to market data
9.5.1 Calibrating to CDS and to bonds
9.5.2 Implied hazard rates
9.5.3 Calibrating to bonds: multiple solutions for the hazard rate
9.5.4 Calibrating to bonds: implied recovery and hazard rates
9.5.5 Implied hazard rate curve and no-arbitrage
9.6 CDS data/sources
9.6.1 Survey data
9.6.2 Data engineering
9.7 Model errors and tests
9.7.1 Recovery assumption
9.7.2 Interest and hazard rate correlation
9.7.3 Reference name and counterparty hazard rate correlation
9.7.4 Interpolation assumptions, and the pseudo-hazard rate versus stochastic hazard rate
9.8 CDS risk factors; reserves and model risk
9.8.1 Captured and hidden risks
9.8.2 Limits
9.8.3 Reserves against implementation errors
9.8.4 Model reserves

10. CDS Deal Examples
10.1 A CDS hedged against another CDS
10.1.1 Cross-currency default swap pricing and hedging
10.1.2 Back-to-back trades, default event hedges and curve trades
10.1.3 Hedging both credit event and spread risk simultaneously
10.1.4 Seniority mismatch
10.1.5 Trade level hedging and book basis hedging
10.2 Introduction to bond hedging
10.2.1 Default event hedging
10.2.2 Spread hedging
10.2.3 Convertible bonds and equity risk
10.3 Hedge and credit event examples

11. CDS/Bond Basis Trading
11.1 Bond versus CDS: liquidity
11.2 Bond repo cost
11.3 Bond spread measurement: z-spread not asset swap spread
11.4 Bond price impact
11.5 Embedded options in bonds
11.6 Delivery option in CDS
11.7 Payoff of par
11.8 Trigger event differences
11.9 Embedded repo option
11.10 Putting it all together

12. Forward CDS; Back-to-Back CDS, Mark-to-Market and CDS Unwind
12.1 Forward CDS
12.2 Mark-to-market and back-to-back CDS
12.3 Unwind calculation; off-market trade valuation and hedging
12.4 'Double-trigger CDS'

13. Credit-Linked Notes
13.1 CLN set-up; counterparty or collateral risk
13.2 Embedded swaps and options
13.3 Costs
13.4 Applications
13.5 CLN pricing
13.5.1 Basic pricing
13.5.2 CLN pricing model
13.6 Capital guaranteed note

14. Digital or 'Fixed Recovery' CDS
14.1 Product description
14.2 Pricing, hedging, valuation and risk calculations
14.2.1 Simple pricing
14.2.2 Recovery assumptions
14.2.3 Valuation and hedging
14.3 Trigger event differences

15. Spread Options, Callable/Puttable Bonds, Callable Asset Swaps, Callable Default Swaps
15.1 Product definitions
15.1.1 Vanilla spread options and variations
15.1.2 Related embedded products
15.1.3 Bond price options
15.1.4 Applications
15.2 Model alternatives and a stochastic default rate model for spread option pricing
15.2.1 Model approaches
15.2.2 Hazard rate tree
15.2.3 Callable high-yield bonds
15.3 Sensitivities and hedging

16. Total Return Swaps
16.1 Product definition and examples
16.2 Applications
16.3 Hedging and valuation
16.3.1 Pricing and hedging
16.3.2 Valuation

17. Single Name Book Management
17.1 Risk aggregation
17.2 CreditVaR for CDS

18. CDS and Simulation
18.1 The Poisson model and default times
18.2 Valuation by Monte Carlo simulation
18.2 Sensitivity


PART III. PORTFOLIO PRODUCTS

19. Nth-to-Default Baskets
19.1 Product definition and features
19.1.1 First-to-default product definition and example
19.1.2 Documentation and takeovers
19.1.3 Second (and higher)-to-default
19.2 Applications
19.2.1 Correlation trading
19.2.2 Mergers
19.2.3 Standard baskets
19.3 Pricing: zero and 100% correlation
19.3.1 Zero correlation case: exact pricing from the CDS model
19.3.2 100% correlation: exact pricing

20. Collateralised Debt Obligations
20.1 Static synthetic CDO
20.1.1 Product definition
20.1.2 Premium waterfall
20.1.3 Documentation; CDO set-up
20.1.4 CDO tranches; funded and unfunded tranches; 'buying' and 'selling'
20.1.5 Relationship to nth-to-default
20.1.6 Arbitrage CDOs
20.2 Index portfolios and Standard CDO structures
20.2.1 Background and terminology
20.2.2 Composition of the indices
20.2.3 Single tranche [0%, 100%] CDO products
20.2.4 Standard tranched CDO structures: iTraxx and CDX
20.2.5 Index options and modelling spread
20.3 CDO terminology and variations
20.3.1 OC and IC tests; WARF; diversity score
20.3.2 Cash and cashflow CDOs
20.3.3 Cashflow waterfall
20.3.4 Managed CDOs
20.3.5 High-grade and high-yield CDOs
20.3.6 Reference assets
20.4 Tranche ratings and BET
20.5 SPVs and CDOs
20.6 Applications
20.6.1 Balance sheet CDOs
20.6.2 Diversification and risk reduction trades; a 'credit bank'

21. Valuation and Hedging
21.1 Default time correlation
21.1.1 Generating correlated default times
21.1.2 Intuitive understanding of default time correlation
21.1.3 Spread implications of 100% default time correlation
21.2 The Normal Copula
21.3 Portfolio product pricing under Monte Carlo simulation
21.3.1 N2D baskets
21.3.2 CDO tranches
21.3.3 The number of simulations
21.3.4 Variance reduction techniques
21.3.5 Complex CDO structures
21.3.6 Summary of the Normal Copula default time simulation and valuation process
21.4 Valuation examples
21.4.1 F2D baskets
21.4.2 CDO pricing: change of correlation
21.4.3 CDO pricing: change of tranching
21.4.4 CDO pricing: change of underlying
21.4.5 CDO pricing: change of maturity
21.5 Sensitivity calculation and hedging
21.5.1 Dynamic hedging: spread risk
21.5.2 Static hedging: default event risk
21.5.3 Correlation risk
21.5.4 Recovery risk
21.5.5 Convexity risks
21.6 Model errors and tests; alternative models
21.6.1 Captured and hidden risks
21.6.2 Spread models
21.6.3 Reserves

22. The Correlation Matrix
22.1 Constraints: what makes a correlation matrix?
22.2 Implied correlation
22.2.1 Index CDO deals and implied correlation
22.2.2 Base correlation
22.2.3 Interpolating correlation
22.2.4 Portfolio differences
22.3 Tag correlation and semi-closed form pricing
22.4 Spread correlation
22.5 Asset and equity correlation
22.6 Calculation techniques
22.6.1 Pairwise estimation from historical data
22.6.2 Factor analysis and correlation
22.6.3 Impact on hedging of using historical or implied correlations

23. Other Copulae
23.1 Student's t distribution
23.2 Copulae in general
23.3 Archimedean Copulae: Clayton and Gumbel
23.4 Clayton at θ =0 and ? θ =
23.5 Model risk

Addendum

24. Correlation Portfolio Management
24.1 Static and dynamic hedges
24.2 Correlation book management
24.3 CreditVaR and CounterpartyVaR


PART IV. DEFAULT SWAPS INCLUDING COUNTERPARTY RISK

25. 'Single Name' CDS
25.1 Non-correlated counterparty
25.2 100% correlation
25.3 Correlated counterparty: pricing and hedging
25.4 Choice of Copula
25.5 Collateralised deals and CDS book management

26. Counterparty CDS
26.1 Pricing
26.2 Counterparty CDS (CCDS) book management

27. The Future for Credit Derivatives
27.1 Development processes
27.2 Conclusion

Appendix: iTraxx Indices
References
Index