Credit Derivatives

2004·4.85 MB·english

by  Geoff Chaplin MA

Credit Derivatives
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Credit Derivatives
Trading, Investing and Risk Management
Second Edition
Geoff Chaplin
MA, DPhil, FFA
A John Wiley and Sons, Ltd., Publication
This edition first published 2010
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ISBN 978-0-470-68644-7
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To my parents, my partner and my children

Contents
Preface to the First Edition xvii
Preface to the Second Edition xix
Acknowledgements xxi
Disclaimer xxiii
Table of Spreadsheet Examples and Software xxvii
About the Author xxix
PART I CREDIT BACKGROUND AND CREDIT DERIVATIVES 1
1 Credit Debt and Other Traditional Credit Instruments 3
1.1 Bonds and Loans; Libor Rates and Swaps; ‘REPO’ and General
Collateral Rates 3
1.1.1 Bonds and Loans 3
1.1.2 BBA Libor and Swaps 4
1.1.3 Collateralised Lending and Repo 4
1.1.4 Repo as a Credit Derivative 6
1.2 Credit Debt Versus ‘Risk-Free’ Debt 6
1.3 Issue Documents, Seniority and the Recovery Process 6
1.3.1 Issue Documents and Default 6
1.3.2 Claim Amount 7
1.3.3 The Recovery Process and Recovery Amount 8
1.3.4 Sovereign versus Corporate Debt 9
1.4 Valuation, Yield and Spread 10
1.5 Buying Risk 10
1.6 Marking to Market, Marking to Model and Reserves 11
1.7 The ‘Credit Crunch’ and Correlation 12
1.8 Parties Involved in the Credit Markets and Key Terminology 13
viii Contents
2 Default and Recovery Data; Transition Matrices; Historical Pricing 15
2.1 Recovery: Ultimate and Market-Value-Based Recovery 15
2.1.1 Ultimate Recovery 15
2.1.2 Market Recovery 16
2.1.3 Recovery Rates and Industry Sector 18
2.1.4 Recovery and Default Rates and the Economic Cycle 18
2.1.5 Modelling Recovery Rates 18
2.2 Default Rates: Rating and Other Factors 21
2.3 Transition Matrices 21
2.4 ‘Measures’ and Transition Matrix-Based Pricing 22
2.5 Spread Jumps and Spread Volatility Derived from Transition Matrices 26
2.6 Adjusting Transition Matrices 27
3 Asset Swaps and Asset Swap Spread; z-Spread 29
3.1 ‘Par–Par’ Asset Swap Contracts 29
3.1.1 Contract Description and Hedging 29
3.1.2 Hedging 29
3.1.3 Default of the Reference Name 30
3.2 Asset Swap Spread 30
3.3 Maturity and z-Spread 30
3.4 Callable Asset Swaps; ‘Perfect’ Asset Swaps 32
3.4.1 Callable Asset Swaps 33
3.4.2 ‘Perfect’ Asset Swaps 33
3.5 A Bond Spread Model 33
4 Liquidity, the Credit Pyramid and Market Data 35
4.1 Bond Liquidity 35
4.2 The Credit Pyramid 35
4.3 Engineered and Survey Data 37
4.3.1 Survey Data 37
4.3.2 Engineered Data 38
4.4 Spread and Rating 39
5 Traditional Counterparty Risk Management 41
5.1 Vetting 41
5.2 Collateralisation and Netting 41
5.3 Additional Counterparty Requirements for Credit Derivative
Counterparties 42
5.4 Internal Capital Charge 42
6 Credit Portfolios and Portfolio Risk 43
6.1 VaR and counterpartyVaR 43
6.2 Distribution of Forward Values of a Credit Bond 43
6.3 Correlation and the Multi-Factor Normal (Gaussian) Distribution 45
6.4 Correlation and the Correlation Matrix 46