3.4.Hull Ch 23

  1. 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
  2. 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)
  3. 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
  4. 2 Credit Indices examples
    • CDX NA IG and iTraxx Europe
    • Both are PF of 125 investment grade
  5. 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
Card Set
3.4.Hull Ch 23