Course Structure

This seminar program provides participants with a comprehensive examination of credit derivative instruments - key products, structures and mechanics - and their role in hedging, credit trading strategies and credit portfolio management. Particular focus is placed on applications within the capital markets i.e. the application of credit derivatives in the synthetic re-structuring of credit risk behavior, for hedging, trading and arbitrage exploitation purposes.

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Day 1

The Credit Derivatives Market

• Market overview

• Evolution and market development

• Recent developments and key issues

• Terminology and nomenclature

• Market participants

• Credit indices (iTRAXX)

Asset Swaps

• Mechanics of pricing and structuring asset
  swaps

• Asset swapping illiquid and structured
  securities (Convertibles)

• Asset swaps and the interrelationship
  between swap and bond markets

• Benefits of asset swaps in credit portfolio
  management

• Asset swap spreads in relative value
  analysis, credit derivative pricing

Case study

Structuring asset swap packages; determining credit spreads

Credit Derivatives: Default Swaps (CDS)

• Definitions and nomenclature

• Credit events – Definitions

• Documentation (ISDA credit default swap
  master agreement)

• Single asset and basket structures, ABS CDS, LCDS

• Settlement mechanisms

  • REDs and CLIPs

  • DTCC, Swapswire clearing and settlement mechanisms

• Credit indices (iTRAXX)

  • ITRAXX index CDS

  • Standardised contract terms

  • Transaction and settlement mechanics

Uses and Benefits of Credit Derivatives

• Credit (portfolio) risk management

• Using credit derivatives to manage and securitise credit risk

• Regulatory capital management

• Credit risk diversification, risk reduction

• Investment applications (Synthetic asset
  generation)

• Leverage (unfunded exposures)

• Yield enhancement (exploiting of credit
  arbitrages)

• Market access (synthetic loan generation)

• Credit trading

Pricing and Valuation of Credit Derivatives

• Components of credit modelling

  • Default probabilities

  • Recovery rates

  • Credit migration

  • Portfolio correlation effects

• Estimation of default probabilities

  • Historical data

  • Equity based (Merton) structural credit models

  • Implied default probabilities (Credit spreads)

  • CreditGrades™

• Credit migration; Transition matrices

• Correlation effects; Joint transition matrices

• Building a default probability curve

• Estimation of recovery rates

• Bootstrapping a CDS curve

• Assumptions and shortcomings in modelling approaches

• Arbitrage based approaches (Asset swap
  pricing)

• Understanding the relationship between CDS premia and asset swap spreads (ASW)

• Impact of repo rates on CDS pricing

• Determinants of the (Asset swap - CDS) basis

Case study
Constructing a default probability function; pricing and valuation credit default swaps

Documentation, Legal and Regulatory Issues

• Master agreement and definitions; confirmations

• Defining credit events

• Current status of restructuring credit event

• Buy-in procedure for cash settlement mechanisms

• Termination, assignment by novation

• Industry protocol on assignment of contracts

• Netting agreements; Legal enforceability of netting arrangements

• Regulatory capital treatment of credit derivatives

• Buyer and seller perspectives

Day 2
CDS risks

• Measuring spread risk (DV01) CDS contracts

• Spread risk convexity

• Default to recovery (DTR) risk

• Isolation of credit spread risk from default
  risk

• Counterparty credit risk

• Operational risks and risk reduction mechanisms

Case study
Measuring CDS spread sensitivity (DV01,
spread convexity)

Active Credit Strategies Using Credit Derivatives

• Active credit strategies

  • Outright and relative value trading strategies

  • Curve trading

  • CB arbitrage, CSA

• Outright and relative value trading strategies

• Sector selection

• Securities selection

• Curve trades

• Constraints and limitations on implementation in ‘long only’ portfolios

• Costs and benefits of using CDS in credit strategy implementation

• Credit risk diversification, risk reduction

• Yield enhancement

• Risks in credit trading strategies (sudden default risk)

Second Generation Credit Derivatives

• Constant maturity CDS (CMCDS)

• Pricing and valuation

• Isolation of credit spread and default risk

• Trading and risk management strategies

• Equity Default Swaps (EDS)

• Benefits and applications of EDS

• Basket default swaps

  • First to Default (FTD) basket CDS

  • Nth to default basket CDS

  • Pricing and valuation of basket CDS

  • Dynamic hedging of basket CDS; gap risk

  • Correlation: impact of credit correlation on basket CDS premia

• Comparison to CDO tranches

• Standardised FTD baskets: analytics and
  settlement mechanisms

• Credit spread options

  • Credit default swaptions

  • Swaption strategies

Case study
Pricing nth-to-default basket CDS structuring; dynamic hedging

Structured Credit Products

• Collateralised debt obligations (CDOs)

• CDO structures

• Cash flow CDOs

• Synthetic CDOs

• Static and managed synthetic CDOs

• Funded and unfunded structures

• CDO developments (CMCDO, CPDO structures)

• Single Tranche CDOs

• Standardised (iTRAXX, CDX) index tranche CDOs

• Modelling CDOs

  • Estimation of loss distributions

  • Transition matrices

  • Extending to credit portfolios

  • Correlation effects; Joint transition matrices

  • Cupola approach

  • Determinants of tranche pricing

• Investor and Issuer motivations

• Costs and benefits of single tranche CDOs

• Single tranche CDO risk characteristics

  • Equity, mezzanine and senior tranche characteristics

• Hedging tranche CDOs, basket CDS

• Dynamic delta hedging

• Convexity

• iGamma, mGamma

• Single tranche CDO trading strategies

  • Quantitative credit trading

  • Credit and correlation trading strategies

  • Carry trades

  • Directional and RV trading strategies

Case study
Relative value analysis
 

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