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University of Hong KongUniversity of Hong Kong

Trading WorkshopTrading Workshop

David Lo

Class 7Class 7

Fixed Income Workshop IIFixed Income Workshop II

Credit Default Swap MarketsCredit Default Swap Markets

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Credit Default Swap (CDS)

• A credit default swap is a bilateral financial contract in which one counterparty (the credit protection party) makes periodic payments to another party in return for a promise of payment contingent on some agreed upon third party reference credit(s) defaulting in respect of some stated observable credit event.

• Default is the non-performance of an agreed obligation.

For example, the non-payment of interest or principal under a swap agreement by one of the parties to the swap would be regarded as default.

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Credit Ratings

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Anyone wants to have insurance in Bond Holdings?Credit Default Swaps

• CDS is a bilateral contract that provides the buyer of the CDS insurance against the risk of default by a particular company.

• Market for products in 2004

Credit Default Swaps79%

Managed Synthetic CDOs

2%

Synthetic Balance Sheet CLOs

8% CLNs3%

Portfolio Default Swaps

6%

Total Return Swaps

1%

Options1%

Managed Synthetic CDOs

Synthetic Balance SheetCLOs

Options

CLNs

Portfolio Default Swaps

Total Return Swaps

Credit Default Swaps

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Who were the end users of CDS?

Asset Managers5%

Hedge Funds8%

Banks (Securitisation)

8%

Special Purpose Vehicles

5%

Reinsurance14%

Insurance9%

Banks 47%

Corporates4%

Insurance

Reinsurance

Special Purpose Vehicles

Banks (Securitisation)

Hedge Funds

Asset Managers

Corporates

Banks

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Credit Default Swap spread (the premium)

• The Credit Default Spread is quoted in Basis Points per annum.

• Paid Quarterly in arrears

1 yr

Tradedate

Buyer of CDS paysquarterly

Seller of CDS protectionreceives quarterly payments

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Credit Default Swap spread (the premium)

• For example, a CDS on Ford Motor Credit is quoted at 80 bps per annum on a notional 10 million USD. The protection buyer will pay -

USD22.222,20360910080.0000,000,10

Notional amount x (Basis Points x days / Day Base)= Quarterly payment

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Credit default Swaps- Credit Events.

• For a Credit Default Swap payment to be made, a credit event on a reference entity’s asset has to have happened. Payment is contingent on the credit event.

• What is a credit event ?- Bankruptcy

- Failure to pay

- Restructuring

- Repayment Acceleration on Default (cross default clauses)

- Repudiation

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Short-tour of the Fixed Income Information in 3000Xtra

• What data in Reuters 3000 Xtra is relevant to CDS?

• CDSINDEX

• GFIINDEX

• HSBC/CDS

• TRACX (Morgan Stanley)

• General

• BONDS (F3)• • Latest ratings with history and news to analyse credit risk, for example RRS0001 shows the ratings history

from full range of ratings agencies; AAA shows credit news alerts

• <RTRTSY1> (US composite. <RTRINDEX> has all of the composite pages)

• <RTRTSY2> (Off the runs)

• <RTRSWP1> (Interest rate SWAPs)

• <CURVES> (F3)

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Customize your CDS Screen (CDS Data, Yield Curve, News)

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Pricing Credit Default Swaps.

• There are two approaches

• Valuation by proxy.

• Mathematical approach.

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Search Credit Default Swap Model from Getgoing

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Credit Default Swap Model – Hutchison CDS Price

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Search CDS from Equity Reference Name

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Search CDS from Equity Reference Name

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Search CDS from Bond ID

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Search CDS Prices from Major Contributors

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Hutchison – Credit Curve

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Correlation : CDS & Share Prices ?

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http://showcase.session.rservices.com

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Credit Default Swap

• Use the Credit Default Swap model to locate a reference credit and analyse the spread history of the credit.  You can compare a reference credit to other reference credits in a peer group.  You can also compare a reference credit to the underlying stock, or to a bond asset swap spread.  The Credit Default Swap model presents the information with the best company and credit default swap (CDS) news in one display.

• Features• View intra-day updates of bid, offer, and dealt CDS spreads from GFI

• View the GFI history of a CDS bid and ask spread

• View intra-day updates of bid and offer CDS spreads from other contributors, such as HSBL and Credit Trade

• View credit reference spreads for over 1,800 entities held in the Reuters database from a number of contributors, including GFI*

• Compare the performance of a CDS spread to the equity price over time in a graph

• Compare a CDS spread against two others CDS spreads over time in a rebase graph

• Compare the history of the CDS spread against the asset swap spread of the selected bond

• Identify news stories linked to historic events in the history of a CDS and related equity 

• Find a specific reference entity from a bond or equity, or from a sector or region

• View all the related issues of a reference credit

• View all the details of the reference credit

• View the best company and CDS news in one display

• View the price and volatility information on the underlying stock

• View asset swap and benchmark spreads for related bonds

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CDS Analysis Model

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CDS Analysis

• CDS Analysis model allows you to price a credit default swap (CDS), and value an existing CDS.

• Features 

• CDS Analysis model calculates:

• CDS spread and premium

• a default probability curve from the CDS spreads

• a CDS spread curve from the contributed spreads using credit risk models

• asset swap spreads from the bonds closest to the CDS maturity

• DV01 for the CDS spread and the risk free zero curve

• valuation of existing CDS

• You can:

• compare CDS spreads against asset swap spreads

• price using the Cox, Ingersoll, and Ross model or a credit event probability curve

• calibrate the credit risk models from CDS spreads or a risky curve

• define a risky curve from interest rate swap prices or related straight bonds

• use your own zero curve for the risk free curve

• view the data in a chart

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Issuer Model

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• Features and benefits

• Using the Issuer worksheet you can:

• Display information on a selected issuer of stocks and/or bonds.

• View information on the sector in which the company is active.

• View a summary of the latest company report.

• View stock/bond listings and Issuer level ratings

• Move to a related worksheet giving further information on a selected stock or bond.   

• The Issuer worksheet provides information about an issuer of stocks and/or bonds, including the sector in which the company is active, selected facts from the latest company report, company news, listings with all issued stocks and bonds, and issuer-level rating, where available. 

•  

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Bond Credit Model

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• Features and benefits

• The Bond Credit worksheet provides the full picture on the credit risk of a bond or an issuer through the integrated display of relevant news, real-time and additional research data. Credit information as well as actions and assignment notices from specific rating agencies is available at the issue and issuer levels. The worksheet also gives an overview of an issuer's credit history.

• With this worksheet you can :

• Obtain an overview of credit news and current and historic rating information on an issuer and issue level.

• View all live bonds from the same issuer.

• Obtain rating actions and credit assignment notices from specific rating agencies such as S&P Creditwire.

• Obtain credit spreads contributed by JP Morgan.

• The Bond Credit worksheet gives you :

• The full picture on the credit risk of a bond or an issuer through the integrated display of relevant news, real time, historic and additional research data.

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Power Plus Pro - FI

• Building Fixed Income spreadsheet and data downloading (Adfin Functions)

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Q & A

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