Credit derivative strategies : new thinking on managing risk and return

238 Pages·2007·2.11 MB·English

by  Douglas, Rohan

Praise for
Credit Derivative Strategies
New Thinking on Managing Risk and Return
edited by Rohan Douglas
“ The Credit Derivative Strategies guide is a great read for the experienced
derivatives professional or those just starting out in the space. Both the
core concepts of the derivatives market as well as the more complex CDO
trading strategies come across with great lucidity. The guide would be a
great complement to anybody’s investment library.”
Brett M. Gearing
Director, Structured Credit Products and Investments,
Babson Capital Management LLC
“ So rapid has been the growth of the credit derivatives market that it has
outpaced the publication of educational material on the topic. Where
texts do exist, they often carry an academic slant of limited application to
the products and strategies employed by more market participants today.
This well-researched volume goes a significant way toward addressing
that imbalance. Written by practitioners with a wealth of both sell- and
buy-side experience, it combines a rigorous approach to product pricing
and valuation with chapters on the equally important—but much less
often seen—topics of risk management and investment strategy. It like­
wise covers not only plain-vanilla CDS and options, but also explains
how to both price and handle the tail risk inherent in CDO tranches.
I recommend this book to portfolio managers, traders, risk managers,
and researchers alike.”
Matt King
Head of Credit Products Strategy, Citigroup
“An excellent mix of quantitative tools and in-depth examples”
Francis A. Longstaff
Allstate Professor of Insurance and Finance,
UCLA Anderson School of Management
“The rapid development of derivatives on credit products in the last
decade has greatly facilitated the ability of participants in global capi­
tal markets to efficiently exchange credit risk. This has contributed to
economic growth by increasing the efficiency of the market for users
of capital. The insights into the latest evolutions of these products,
contained in this book, provide an invaluable resource for a broad
range of market participants and observers.”
Stephen West
Founding Partner, TriPoint Asset Management
“ Credit Derivative Strategies meets the challenge of bringing fi nancial
analysts and risk managers up to date on valuation, risk assessment, and
product design in the fast-moving market for credit derivatives. The
chapters are well selected for a mix of pragmatic institutional knowl­
edge, conceptual frameworks, and technical foundations. I recommend
it highly.”
Darrell Duffie
Dean Witter Distinguished Professor of Finance, Codirector of the
Credit Risk Executive Program, Graduate School of Business,
Stanford University
Credit

Derivative

Strategies
Also available from Bloomberg Press
The Credit Default Swap Basis
by Moorad Choudhry
Fixed-Income Securities and Derivatives Handbook:

Analysis and Valuation

by Moorad Choudhry
Inside the Yield Book:

The Classic That Created the Science of Bond Analysis

by Sidney Homer and Martin L. Leibowitz, PhD
Introduction to Option-Adjusted Spread Analysis:

Revised and Expanded Third Edition of the OAS Classic by Tom Windas

revised by Tom Miller
Hedge Fund Risk Fundamentals:

Solving the Risk Management and Transparency Challenge

by Richard Horwitz
———
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Attention Corporations
This book is available for bulk purchase at special discount. Special
editions or chapter reprints can also be customized to specifi cations.
For information, please e-mail Bloomberg Press, [email protected],
Attention: Director of Special Markets, or phone [phone].
Credit

Derivative

Strategies

,

New Thinking on

Managing Risk and Return

edited by
Rohan Douglas
Bloomberg Press

New York
© 2007 by Rohan Douglas. All rights reserved. Protected under the Berne Convention. Printed in the
United States of America. No part of this book may be reproduced, stored in a retrieval system, or trans­
mitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise,
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The Chartered Financial Analyst® (CFA®) designation is a globally recognized standard for measuring
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This publication contains the authors’ opinions and is designed to provide accurate and authoritative
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planning decisions made by the reader.
First edition published 2007
1 3 5 7 9 10 8 6 4 2
Library of Congress Cataloging-in-Publication Data
Credit derivative strategies : new thinking on managing risk and return / edited by Rohan Douglas.
p. cm.
Summary: “Credit Derivatives are financial contracts that transfer credit risk--the risk that a debtor
will not repay a loan--between parties. Credit Derivative Strategies describes for professional inves­
tors current ways of participating in this rapidly expanding market, including how to select credit
hedge funds, analyze event risk, find relative value opportunities, and choose synthetic collateralized
debt obligations (CDOs)”--Provided by publisher.
Includes bibliographical references and index.

ISBN 978-1-57660-187-7 (alk. paper)

1. Credit derivatives. 2. Risk management. I. Douglas, Rohan.
HG6024.A3C737 2007
332.63'2--dc22 2007014284
C O N T E N T S

About the Contributors ..................................................... vii

Introduction ...................................................................1

PART ONE | INVESTMENT STRATEGIES
1 Eight Relative Value Opportunities ..................................7

Christoph Klein, CFA, Head of Credit Fixed Income and
Partner, TriPoint Asset Management
2 Distressed Debt Strategies .............................................25

Steven D. Persky, CFA, Founder and Managing Partner,
CEO, Dalton Investments
3 Four Synthetic CDO Trading Strategies .........................33

Andrea Petrelli, Director of European CDO Trading Risk
Management, Credit Suisse
Jun Zhang, PhD, CFA, Head of U.S. CDO Risk Management,
Credit Suisse
Santa Federico, Chief Risk Officer, Perry Capital
Vivek Kapoor, Executive Director, UBS
4 Integrating Credit Hedge Funds into a Portfolio
of Investments ..............................................................65
Richard Horwitz, Managing Director, Hedge Fund
Development and Management Group, Merrill Lynch
Erin Roye Simpson, Associate, Hedge Fund
Development and Management Group, Merrill Lynch
PART TWO | RISK MANAGEMENT STRATEGIES
5 Risk Management of Credit Derivatives..........................93

Santa Federico, Chief Risk Officer, Perry Capital
Andrea Petrelli, Director of European CDO Trading Risk
Management, Credit Suisse
Jun Zhang, PhD, CFA, Head of U.S. CDO Risk Management,
Credit Suisse
Vivek Kapoor, Executive Director, UBS
6 Risk Management for Multistrategy Funds ................... 115

Christoph Klein, CFA, Head of Credit Fixed Income and
Partner, TriPoint Asset Management
7 Integrating Event Risk in Portfolio Construction .......... 123

Alla Gil, Former Managing Director, International Capital
Solutions Group, Nomura Securities International
PART THREE | PRICING, PRODUCTS,
AND PROCEDURES
8 Pricing Models ............................................................ 145

Rohan Douglas, Founder and CEO, Quantifi Inc.
Peter Rivera, Professor of Business Technologies,
SUNY-Dutchess
9 CDS Valuation ............................................................ 161

Santa Federico, Chief Risk Officer, Perry Capital
Andrea Petrelli, Director of European CDO Trading Risk
Management, Credit Suisse
Jun Zhang, PhD, CFA, Head of U.S. CDO Risk Management,
Credit Suisse
Vivek Kapoor, Executive Director, UBS
10 CDO Valuation ........................................................... 167

Santa Federico, Chief Risk Officer, Perry Capital
Andrea Petrelli, Director of European CDO Trading Risk
Management, Credit Suisse
Jun Zhang, PhD, CFA, Head of U.S. CDO Risk Management,
Credit Suisse
Vivek Kapoor, Executive Director, UBS
11 Credit Derivative Products ............................................175

Peter Rivera, Professor of Business Technologies,
SUNY-Dutchess
Index ............................................................................ 217

CFA Institute Professional Development
Qualifi ed Activity (7.5 hours) ................................. 224
A B O U T THE C O N T R I B U T O R S
Rohan Douglas, editor of this volume, is the founder and CEO of Quantifi
Inc., a leading provider of pricing models and risk analysis tools for struc­
tured credit. He has more than twenty-five years of experience in the global
fi nancial industry. Prior to founding Quantifi, he was the director of global
credit derivatives research at Citigroup and Salomon Smith Barney where
he worked for ten years. Douglas has worked in interest-rate derivatives,
emerging markets, and global fixed income. Douglas is also an adjunct
professor in the financial engineering program at Polytechnic University in
New York and at the Macquarie University Applied Finance Centre in
Australia and Singapore. For many years, Douglas has spoken at confer­
ences and seminars on the subject of credit derivatives.
Santa Federico is the chief risk officer for Perry Capital, a $13 billion mul­
tistrategy hedge fund. Prior to working at Perry Capital, he was managing
director of strategic risk management at Credit Suisse First Boston and head
market risk manager for Salomon Smith Barney/Citigroup. Besides risk
management, he has held various positions in portfolio management, de­
rivatives trading, and quantitative research. He has twenty years of fi nancial
industry experience and holds degrees in physics from Princeton University
and the École Centrale de Paris.
Alla Gil has fourteen years of financial experience working at major banks,
such as Citigroup, Goldman Sachs, and CIBC. Most recently, she was the
managing director of International Capital Solutions Group for Nomura
Securities International. Her group developed innovative and practical
financial solutions by quantifying clients’ exposures to different risk facets
and identifying the most efficient risk mitigation strategies.
vii