Structured Finance - Credit Derivatives

Explore how credit derivatives transfer credit risk in structured finance, learning pricing, forms, and over-the-counter trading methods, and distinguish asset side versus liability side products.

Explain asset side products that generate returns on cash and liability side products that manage cash outflows. Use cross-currency swaps, as in Infosys, to hedge dollar liabilities into INR.

Evaluate how credit risk impacts the balance sheet and capital allocation by using ratings from Fitch, S&P, Moody's, from triple A to junk, and understanding default and credit events.

Credit default swaps transfer credit risk by insuring a reference entity against default, enabling hedging and risk transfer between protection buyer and seller through a premium.

credit default swaps resemble insurance contracts but the reference entity's obligation can be traded via a third party, enabling credit risk transfer, hedging, and speculative bets.

Explore how ISDA standardizes credit default swap contracts, detailing trade and effective dates, fixed and floating payments, reference entity and obligation, and events like bankruptcy and restructuring.

Explore how credit default swaps are priced and traded, define obligations as loans or bonds, and show how dealers quote five-year CDS contracts across maturities.

Price a CDS for Turkey using a 5% risk-free rate and 2% default probability, calculating the present value of spread payments and accrued premium from survival probabilities and discount factors.

Calculate CDS pricing by equating expected premium payments with default-probability adjusted payments, using discounting to derive the spread (for example 83 basis points for Turkey) and bootstrapping to track MTM.

Calculate accrued premium and value CDS mark-to-market by comparing expected payments under changing default probabilities. Explain how widening spreads create negative MTM for buyers and positive MTM for sellers.

Bootstrap default probabilities from the cds term structure using observed prices and a 5% risk-free rate. Solve for year-by-year defaults p1, p2, using expected payments for protection buyer and seller.

Extract default probabilities from a bond term structure using survival and recovery. Demonstrate the equivalence of bonds and cds and how cds can replicate a bond for synthetic cash.

Examine how a default double bond is equivalent to a risk-free bond plus a CDS, and how CDS replication can mimic bond exposure, revealing arbitrage in credit derivatives.

Credit linked notes mirror bond risk via credit default swaps, enabling five-year exposure when a five-year bond is unavailable, and illustrating hedging, protection selling, and the bond CDS basis.

Explore other credit derivatives, including credit linked notes with custom ranges and range accruals, and learn CDS forwards and options with hedging via volatility.

A total return swap, a credit derivative, transfers the bond's total return from party B to party A. A pays three month LIBOR plus 50 basis points.

An asset swap converts a fixed-coupon bond to a floating exposure by swapping fixed payments for three-month libor plus an asset swap spread, priced to par.

Explore basket default swaps by deriving the price of a defaultable zero-coupon bond, showing how yield, the risk-free rate, recovery, and the CDS spread relate.

Show how the cds spread is proportional to the loss on default and the probability of default, and how first-to-default basket structures use union probability and correlation.

Analyze how the probability of two entities defaulting combines as p(a)+p(b) minus p(a∩b), highlighting independence vs perfect correlation and the resulting impact on basket cds spreads and protection seller profits.

Explore the essentials of credit derivatives, including pricing, valuation, and forms like total return swaps and basket default swaps, and how synthetic CDOs fit into securitization.