Credit Derivatives von Edu Pristine

Dozent des Vortrages Credit Derivatives

Edu Pristine

Trusted by Fortune 500 Companies and 10,000 Students from 40+ countries across the globe, EduPristine is one of the leading International Training providers for Finance Certifications like FRM®, CFA®, PRM®, Business Analytics, HR Analytics, Financial Modeling, Operational Risk Modeling etc. It was founded by industry professionals who have worked in the area of investment banking and private equity in organizations such as Goldman Sachs, Crisil - A Standard & Poors Company, Standard Chartered and Accenture.

EduPristine has conducted corporate training for various leading corporations and colleges like JP Morgan, Bank of America, Ernst & Young, Accenture, HSBC, IIM C, NUS Singapore etc. EduPristine has conducted more than 500,000 man-hours of quality training in finance.
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... event, settlement mechanism and deliverable obligation. Define and discuss funded and unfunded instruments. List the types of credit events contained in a standard ISDA credit derivatives document. Define and discuss credit default swaps (CDS) and their prospective cash flows. Define ...

... flows to each. List various credit enhancements. Discuss synthetic CDOs and their prospective cash flows. Define reference portfolio. Define first-loss piece. Describe unfunded, partially funded, fully funded and fully unfunded synthetic CDOs. Define super-senior swap. Discuss some uses, advantages and limitations of ...

... protection buyer to the protection seller, and a payout in the event of a specified credit event. They are OTC products and can be designed to meet specific user requirements. A number of events may be defined as credit events that fall short of full bankruptcy, administration or liquidation of a company. Contracts may be required to pay out under both technical as well as actual ...

... a credit default swap (CDS). This may be desirable for assets that cannot be sold for client relationship or tax reasons. For instance, a bank can buy credit protection on a BB-rated entity from a AA-rated bank. It then has eliminated its credit risk to the BB entity, and substituted it for AA-rated counterparty risk. Notice that as the bank retains a counterparty risk to the CDS issuer, one could argue that its credit risk exposure is never completely removed but transferred. In practice this is not a serious problem since the bank can manage counterparty ...

... protection to SBI for 2.5%. ABC gains 0.50% additional income for same credit risk exposure. SBI locks in credit-risk free investment and making 2.5% after funding costs. Enhancing portfolio returns: Asset managers can derive premium income by trading credit exposures in the form of derivatives issued with synthetic structured notes. Credit switches and zero-cost credit exposure: In a credit switch the portfolio manager purchases credit protection on one reference asset ...

... a liquidity or delivery squeeze, as it is a specific credit risk that is being traded. In the cash market it is not possible to ‘sell short’ a bank loan, for example, but a credit derivative can be used to establish synthetically the same economic effect. Credit derivatives allow investors access to specific credits while allowing banks access to further distribution for ...

... is used to position the CDS in the capital structure of the reference entity. The buyer however does not have to deliver this specific obligation. Any obligation that ranks pari passu with the Reference Obligation can be delivered by the Protection Buyer (or used as the final Reference Obligation in most cash settled CDS). If no Reference Obligation is specified, Senior Unsecured obligation is assumed. Deliverable Obligation: that the protection buyer delivers ...

... Change in the ranking of the debt. Change in the currency of payment (other than into certain permitted currencies). Obligations default or obligations acceleration: These are rarely used in practice. Under obligation acceleration, creditors must take action to require immediate payment of amounts owed under the obligation. Under obligation default, creditors must have the right to take action but may or may not have done so. Repudiation or debt moratorium: ...

... fortunes of the issuer improve. Despite this, swap market-making banks often prefer cash settlement as there is less administration associated with it. It is also more suitable when the swap is used as part of a synthetic structured product, because such vehicles may not be set up to take delivery of physical assets. Also the Cash ...

... credit events. The advantage of this to the protection buyer is that it is not exposed to the credit risk of the protection seller. Typified by a credit-linked note (CLN), the investor in the note is the credit protection seller and is making an upfront payment to the protection buyer when it buys the note. Thus, the protection buyer is the issuer of the note. If no credit event occurs during the life of the note, the redemption value of the ...

... a payoff (protection or default leg) if an underlying financial instrument defaults. CDS are similar to credit insurance policies or financial guarantees on the credit risk of corporations. Credit risk is transferred from the “Seller” to the “Buyer” for an amount ...

... of 75bps Example: The only cash flows (pre Credit Event) are the premium payments made by the Buyer of protection. CDS premium is exchanged until the occurrence of a Credit Event, or ...

... contracts trade with “Physical Settlement” Settlement Methods. Post the Credit Event, the CDS terminates and no further payments are made by either party. Post a credit event, ...

... amount equal to the Swap Notional. Example: USD 5 Million. Protection buyer delivers to the seller a qualifying debt instrument (the “Deliverable Obligation”) of the “Reference Entity”. The deliverable obligation can be any obligation meeting a specified list of criteria; the Reference Entity is the company that protection is being traded on. The face amount ...

... loan rather than any other asset class (e.g. bonds (corporate or sovereign), unsecured loans, asset-backed securities, etc), they are also called syndicated secured loan CDS. Pay-as-you-go ...

... company (the Reference Entity). Triggering a Credit Event will involve public information of a material event with respect to one of their Obligations. Once credit event has occurred, any Obligation of the Reference Entity, which meets a range of criteria (seniority, currency, tenor, ...

... fixed maturity structure similar to a vanilla bond. CLNs can be issued by financial institutions or by SPVs The performance of the note, however, including the maturity value, is linked to the performance of a specified underlying asset or ...

... CDS Counterparty (Protection Buyer) Special Purpose Vehicle Highly rated Collateral Investor (Protection Seller) 150 bp pa Default Swap Premium Coupon LIBOR Coupon LIBOR + 150 bp(pa) A typical SPV will have two assets securing its obligations: –Highly rated collateral (e.g., AAA rated credit card securities –a ...

... and receives the premium The investor receives the coupon from the collateral plus the credit default premium If there is no Credit Event, then at maturity of the note the investor gets back par (from the redemption proceeds of the collateral) Following a Credit Event, the noteholder will be delivered an obligation of the Reference Entity (or a cash amount equal ...

... quality of the reference asset; –The funding costs of the beneficiary bank; –Any required profit margin; –The capital charge associated with the TR swap. TRS counterparties must consider a number of risk factors associated with the transaction, which include: –The probability that the TR beneficiary may default while the reference asset has ...

... + Short CDS (protection seller) =Long risky bond TR payer = Short risk-free bond + Long CDS (protection buyer) =Short risky asset Total economic performance of an asset is exchanged for another cash flow (L+/- spread) TR payer (protection buyer) pays to TR receiver (protection seller) total returns from the asset ( are the interest payments) and ...

... plus a spread. If the bond yield exceeds the LIBOR spread, the funding will be negative; however, the trade will gain if the trader’s view is proved correct. Capital Structure Arbitrage : describes an arrangement whereby investors exploit mispricing between the yields received on two different loans by the same issuer. Assume that the reference entity has both a commercial bank loan and a subordinated bond issue outstanding, but that the former pays LIBOR plus 330 basis points while the latter pays LIBOR plus 230 basis points. An investor enters into a TRS in which it is effectively purchasing the bank loan and selling short the bond. The nominal amounts will be at a ratio of, ...

... entered into to begin with. –Consider a broker-dealer that has a portfolio of assets on its balance sheet that it needs to obtain funding for. These assets are investment-grade structured finance bonds. 1st Option – in the repo market, it is able to fund these at LIBOR + 6 basis points. That is, it can repo the bonds out to a bank counterparty, and will pay LIBOR plus 6 bps on the funds it receives. –Assume that for operational reasons the bank can no longer fund these assets using repo. 2nd Option - It can fund them using a basket TRS instead. The broker-dealer ...

... the underlying credit- sensitive asset or credit spread. The writer of credit options seeks to earn premium income. Pay-off of credit spread put = max(Credit Spread – Strike Spread, 0) Pay-off of credit spread call = ...

... Treasury yields remain constant over the horizon and that the required spread on IBM bonds widens from 180 basis points to 200 basis points. What is the net payout to the buyer of the credit spread option? A.USD -437,000 B. USD 0 B.USD 137,000 C. USD 437,000 ANSWER: C; The value of the credit spread option is given by: Max{[(PSS – PAS)/100]*notional,0} where PSS is the bond’s price at the strike spread and PAS is the bond’s price at the actual, prevailing spread in the market at option expiration. ...

... incorporated legal entity, the SPV. In a synthetic CDO a synthetic securitization structure is engineered so that only the credit risk of the assets is transferred by the sponsor, from itself to the investors, by means of credit derivative instruments. The loans or bonds themselves are not legally transferred. They normally remain on the sponsor’s balance sheet. It is just the credit risk of the asset pool (now known as the reference portfolio) that is transferred, using credit derivatives. The sponsor is the credit protection buyer and the investors are the credit protection sellers. Synthetic CDOs is achieved with credit ...

... purchases the assets and their associated cash flows from the originator, thus taking the assets off the latter’s balance sheet; this is viewed as a ‘true sale’ that is, in legal and practical terms a completely separate legal entity (the SPV) has actually purchased the assets from the sponsor. The funds used to purchase the assets are raised through the issue of bonds ...

... Note (AAA) “B” Note (A) Mezzanine Tranche Note (BB) Junior Note/ Equity Piece Underlying Assets (bonds, loans, etc) Trustee Portfolio Loss Portfolio Cash Flow Note Proceeds Assets “true sale” CDO note Assurance Issue Proceeds -A typical note tranching of the pool of assets might be: –Senior note, AAA-rated, comprising 90–95% ...

... each Tranche, the lower tranche boundary is called the attachment point, while the upper tranche boundary is called the detachment point. Based on their risk appetite, investors can take exposure to a particular tranche. At all times, the total cash flows, value, and risk of the tranches must equal those of the collateral. If some tranches are less risky than the collateral, others must be more risky. Example: As and when portfolio losses exceed ...

... tranches of notes from a repackaging of corporate bonds, ranging from equity to super senior. Which of the following is generally true of these structures? A.The total yield of all the CBO tranches is slightly less than the underlying repackaged bonds to allow the issuer to recover fees/costs/ profits. B.The super senior tranche has expected loss rate higher than the junior tranche. C.The super senior tranche is typically rated below AAA and ...

... compared to the underlying pool; for example, $250m nominal of assets are used as backing for $170m nominal of issued bonds. Cash reserve accounts A reserve is maintained in a cash account and used to ...

... note, known as the first-loss piece, is often retained by the sponsor. Thus, on occurrence of a credit event among the reference assets, the originating bank receives funds remaining from the collateral only after they have been used to pay the principal on the issued notes, less the value of the junior note. Uses of synthetic CDO Capital relief: the sponsor can obtain regulatory capital relief (because reference assets that are protected by credit derivative contracts, and which ...

... compared to the underlying pool; for example, $250m nominal of assets are used as backing for $170m nominal of issued bonds. -Cash reserve accounts A reserve is maintained in a cash account and used to ...

... known as the first-loss piece, is often retained by the sponsor. Thus, on occurrence of a credit event among the reference assets, the originating bank receives funds remaining from the collateral only after they have been used to pay the principal on the issued notes, less the value of the junior note. Uses of synthetic CDO -Capital relief: the sponsor can obtain regulatory capital relief (because reference assets that are protected by credit derivative contracts ...

... on 100 Reference Entities earning CDS spreads as return CDS Spread on Portfolio of 100 CDS Protection for Credit Events on Portfolio of 100 ...

... proceeds from the notes are invested in risk-free government or agency debt or in senior unsecured bank debt. Should there be a default on one or more of the underlying assets, the required amount of the collateral is sold and the proceeds from the sale paid to the issuer to recompense for the losses. ...

... -There is no requirement to fund the super senior element. -Transaction costs such as legal fees can be lower as there is no necessity to set up an SPV. -Banking relationships can be maintained with clients whose loans need not be actually sold off the sponsoring entity’s balance ...

... C. Protection Leg means the payoff the buyer makes to the seller if the underlying asset defaults D. CDS are similar to credit insurance policies. -A portfolio manager believes that a particular bond (which he does not hold) is about to decline in ...

... into account the credit rating of the swap counterparty D. TRS is a swap agreement in which the total return of a bank loan or credit-sensitive security is exchanged for some other cash flow. -Bank A has made a $300 million loan to a software company at a fixed rate of 15%. ...

... position in repo, else he can enter into a TRS -A. Enter into a Total Return Swaps. -TRS counterparties must consider a number of risk factors associated with the transaction -A. TRS transaction can be risk free. ...