CDS
CDS - correct answer ✔isolate credit risk of a FI security
- two parties: protection buyer, protection seller (usually a dealer)
Reference obligation - debt instrument issued by the reference entity
Protection buyer buys credit protection from the protection seller and pays
periodic CDS spread pmts (fixed at inception) for the coverage....and then
dealer assumes credit risk, and would make default payment if default occurs
during swap
Obligations and risks of different parties - correct answer ✔Protection buyer:
"short credit risk"...and is obligated to make CDS spread payments
Protection seller: "long credit risk" and is obligated to make a payment if a
credit event occurs
A CDS on a specific borrower is called a "single-name CDS" (ex: bonds
issued by 1 borrower, NOT a portfolio)
==> Payoff on single-name CDS is based on the "cheapest-to-deliver" CTD
obligation with the same seniority
When default occurs, CDS ceases to exist
Index CDS - correct answer ✔A CDS on an equally weighted combo of
borrowers is called an INDEX CDS
, Credit correlation is important factor in pricing index CDS
Index (equally weighted!):
- CDX-IG (NA) - # of entitites = 125
- CDX - HY (NA) = 100
- iTraxx Main - Eur, Asia, Austr -IG = 100
- iTraxx Crossover - Eur, Asisa, Austr HY = 50
so if we have $100M on CDX HY - so if one constituents defaults out of
CDXHY, then underlying notional principal attributable to this defaulter is
$1M... ONCE DEFAULT, notional P is adjusted DOWNWARD... so $99M (bc
now 99 entities)
CDS Spreads - correct answer ✔Standardization in CDS market makes CDS
coupon (premium payment) IS NOT EQUAL TO CDS spread
- if spread higher than rate, then buyer is advantaged
ex: 1% coupon IG, 5% coupon HY...not all IG are going to have credit spread
for ex of 1% (standardization forces buyer to pay standard % tho...)
Hence, an upfront payment is made by one of the counterparties to the CDS
(THE ONE THAT IS ADVANTAGED); this is called the upfront premium
Credit Events - that would trigger a payoff from protection seler
- bankruptcy
CDS - correct answer ✔isolate credit risk of a FI security
- two parties: protection buyer, protection seller (usually a dealer)
Reference obligation - debt instrument issued by the reference entity
Protection buyer buys credit protection from the protection seller and pays
periodic CDS spread pmts (fixed at inception) for the coverage....and then
dealer assumes credit risk, and would make default payment if default occurs
during swap
Obligations and risks of different parties - correct answer ✔Protection buyer:
"short credit risk"...and is obligated to make CDS spread payments
Protection seller: "long credit risk" and is obligated to make a payment if a
credit event occurs
A CDS on a specific borrower is called a "single-name CDS" (ex: bonds
issued by 1 borrower, NOT a portfolio)
==> Payoff on single-name CDS is based on the "cheapest-to-deliver" CTD
obligation with the same seniority
When default occurs, CDS ceases to exist
Index CDS - correct answer ✔A CDS on an equally weighted combo of
borrowers is called an INDEX CDS
, Credit correlation is important factor in pricing index CDS
Index (equally weighted!):
- CDX-IG (NA) - # of entitites = 125
- CDX - HY (NA) = 100
- iTraxx Main - Eur, Asia, Austr -IG = 100
- iTraxx Crossover - Eur, Asisa, Austr HY = 50
so if we have $100M on CDX HY - so if one constituents defaults out of
CDXHY, then underlying notional principal attributable to this defaulter is
$1M... ONCE DEFAULT, notional P is adjusted DOWNWARD... so $99M (bc
now 99 entities)
CDS Spreads - correct answer ✔Standardization in CDS market makes CDS
coupon (premium payment) IS NOT EQUAL TO CDS spread
- if spread higher than rate, then buyer is advantaged
ex: 1% coupon IG, 5% coupon HY...not all IG are going to have credit spread
for ex of 1% (standardization forces buyer to pay standard % tho...)
Hence, an upfront payment is made by one of the counterparties to the CDS
(THE ONE THAT IS ADVANTAGED); this is called the upfront premium
Credit Events - that would trigger a payoff from protection seler
- bankruptcy
