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Credit Derivatives

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248 pages
The market for credit derivatives--financial instruments designed to transfer credit risk from one party to another--has grown exponentially in recent years, with volume expected to reach more than $4.8 trillion by 2004. With demand increasing from the private sector for finance professionals trained in the opportunities--and dangers--inherent in this fast-changing market, finance courses are already springing up to meet this need.

Credit Derivatives:


  • Explains the field of credit derivatives to business students with a background in finance
  • Cites real-world examples throughout, reinforced by end-of-chapter questions and internet links to pricing models
  • Provides a concise overview of the field that is ideal for instructors seeking to supplement traditional derivatives course material, as well as those looking to offer a stand-alone course on credit derivatives.
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Contents
Preface
Introduction
Chapter 1
Chapter 2
The Basics of Credit Derivatives
What is Credit Risk? What are Credit Derivatives? Why Credit Derivatives?
The Market for Credit Derivatives
Credit EventsThat Have Led to the Birth of Credit Derivatives Market Size and Products Credit Derivatives Have Been Around in Different Forms The QBI Contract Creditex and CreditTrade Trac-x and Iboxx Summary of Chapter 1 References and Suggestions for Further Readings Questions and Problems Notes
Credit Derivatives Products
Default Swaps What is a default swap? Why default swaps? The terminology
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Contents
Chapter 3
Features of default swaps The default swap premium The reference obligation What constitutes default? Cash versus physical settlement Hedging with default swaps Does a default swap hedge credit deterioration risk? Does a default swap hedge against market risk? Types of default swaps Key benefits of default swaps Total Rate of Return Swaps (TRORs) What is a TROR? Why TRORs? Hedging with TRORs The difference between a TROR and a default swap The difference between a TROR and an asset swap The difference between a TROR and an equity swap The relationship between a TROR and a Repo Key benefits of TRORs Credit-spread Products Credit-spread options Hedging with credit-spread options Credit-spread forwards Credit-spread swaps When to hedge and with what credit-spread product Summary of Chapter 2 References and Suggestions for Further Readings Questions and Problems Notes
Synthetic Structures
Credit-Linked Notes (CLNs) A More Complex Credit-Linked Note Structure Collateralized Debt Obligations (CDOs) Synthetic CDOs A two-currency, partly cash, partly synthetic CDO with embedded hedges Motivation for CDOs Market value CDOs and cash flow CDOs Tranched Portfolio Default Swaps (TPDS) Tranched Basket Default Swaps (TBDSs) CDO Squared Structures Rating Recovery rates Coverage ratios Notching
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Chapter 4
Chapter 5
Successful Synthetic Structures Investing in Synthetic Structures – A Good Idea? Summary of Chapter 3 References and Suggestions for Further Readings Questions and Problems Notes
Application of Credit Derivatives
Contents
Hedging Market risk Credit risk How are market risk and credit risk related? Operational risk Which credit derivative hedges which risk? Yield Enhancement Cost Reduction and Convenience Cost reduction Convenience Arbitrage Regulatory Capital Relief The Basel II Accord Standardized versus IRB approach Banking book versus trading book Risk weights for positions hedged by credit derivatives in the banking book Risk weights for positions hedged by credit derivatives in the trading book The BIS minimum capital requirement for combined credit, market, and operational risk Summary of Chapter 4 References and Suggestions for Further Readings Questions and Problems Notes
The Pricing of Credit Derivatives
Credit Derivatives Pricing Approaches Simple Approaches The default swap premium derived from asset swaps Deriving the default swap premium using arbitrage arguments “I price it where I can hedge it:” Pricing default swaps using hedging arguments Deriving the default probability and the upfront default swap premium on a binomial model Basic properties of the Black-Scholes-Merton model Valuing credit-spread options on a modified Black-Scholes equation where the credit-spread is modeled as a single variable
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Contents
Chapter 6
Valuing credit-spread options on a modified Black-Scholes equation as an exchange option Valuing credit-spread options on a term-structure based model Structural Models The original 1974 Merton Model The Black-Cox 1976 model The Kim, Ramaswamy, and Sundaresan 1993 model The Longstaff-Schwartz 1995 model The Briys-de Varenne 1997 model Critical appraisal of first-time passage models Reduced Form Models The Jarrow-Turnbull 1995 model Critical appraisal of the Jarrow-Turnbull 1995 model The Jarrow-Lando-Turnbull 1997 model Critical appraisal of the Jarrow-Lando-Turnbull 1997 model Other Reduced Form Models Duffie and Singleton (1999) Das and Sundaram (2000) Hull and White (2000) Hull and White (2001) Kettunen, Ksendzovsky and Meissner (2003) The KKM model in combination with the Libor Market Model (LMM) Pricing TRORs Further research in valuing credit derivatives Summary of Chapter 5 References and Suggestions for Further Readings Questions and Problems Notes
Risk Management with Credit Derivatives
The VAR Concept Market VAR for a single linear asset Market VAR for a portfolio of linear assets Market VAR for non-linear assets Market VAR for a portfolio of options Credit at Risk (CAR) Determining CAR of investment grade bonds Accumulated expected credit loss CAR for a portfolio of assets Reducing portfolio CAR with credit derivatives Reducing CAR with default swaps Reducing CAR with TRORs Reducing CAR with credit-spread options The correlation of credit risk management with market risk management and operational risk management
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Appendix
Recent Advances in Credit Risk Management – A Comparison of Five Models Credit risk models – structural versus reduced form Key features of credit risk models The Models in Detail KMV’s Portfolio Manager JP Morgan’s CreditMetrics Kamakura’s Risk Manager CSFP’s Credit Risk+ McKinsey’s Credit Portfolio View Results So what’s the best model? Summary of Chapter 6 References and Suggestions for Further Readings Questions and Problems Notes
Table A.1 Table A.2
Glossary of Notation
Glossary of Terms
Index
Contents
The cumulative standard normal distribution The cumulative lognormal distribution
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