3.4.Hull Ch 23

Home > Preview

The flashcards below were created by user Exam9 on FreezingBlue Flashcards.

Define Credit Default Swaps (CDS)

Insurance against a default by a particular company on a particular issuance of debt. It involves periodic pmt by the party purchasing the ins and, in the event of default, a pmt by the seller
Credit Swaps definitions
Reference entity, reference obligation, notional principal, credit event
- Reference entity: entity whose credit rating is being protected
- Reference obligation: bond used to monitor wheter a credit event occurs and to determine swap payoff
- Notional principal: par value of the reference obligation
- Credit event: default (could be default of other obligations)
CDS Spread definition and mathematical approach
- CDS Spread = pmt rate such that PV(buyer) = PV(seller)
- Step 1: determine unconditional default probability
- Step 2: determine buyer's pmts (annual spread and accrual pmt when default occurs)
- Step 3: determine seller's pmt
- Step 4: solve for spread, s
2 Credit Indices examples
- CDX NA IG and iTraxx Europe
- Both are PF of 125 investment grade
Cash vs Synthetic CDO

Objective of CDO is largely to transfer credit risk → no need to contain actual bonds (only credit default swaps). In that case we call it a synthetic CDO