Understanding Credit Derivatives and Related Instruments, 1st Edition, Author: Antulio Bomfim, Published: December 2004, ISBN: 9780121082659, Academic Press, Hardbound

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Understanding Credit Derivatives and Related Instruments, 1st Edition, Author: Antulio Bomfim, Published: December 2004, ISBN: 9780121082659, Academic Press, Hardbound



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Product Details


Series: Academic Press Advanced Finance

Hardcover: 368 pages

Publisher: Academic Press; 1 edition (December, 2004)

Language: English

ISBN-10: 9780121082659

ISBN-13: 978-0121082659

ASIN: 0121082652

Product Dimensions: 9.1 x 6.3 x 1 inches

Shipping Weight: 1.5 pounds


Key Features


* 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




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.




Graduate Students in MBA and specialized finance programs, professionals working with investment tool such as financial analysts and portfolio managers.


Table of Contents


Understanding Credit Derivatives and Related Instruments, 1st Edition


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 Stochastic interest rates Forward default probabilities Forward default rates
17.2.2 Uncertain Time of Default 
17.2.3 Default Intensity 
17.2.4 Pricing Defaultable Bonds Non-zero recovery 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 The reference entity Reference and deliverable obligations Settlement method 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

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