University of Hong Kong

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University of Hong Kong Trading Workshop
Class 7 Fixed Income Workshop II Credit Default
Swap Markets
David Lo
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Credit Default Swap (CDS)

• A credit default swap is a bilateral financial
  contract in which one counterparty (the credit
  protection party) makes periodic payments to
  another party in return for a promise of payment
  contingent on some agreed upon third party
  reference credit(s) defaulting in respect of some
  stated observable credit event.
• Default is the non-performance of an agreed
  obligation. For example, the non-payment of
  interest or principal under a swap agreement by
  one of the parties to the swap would be regarded
  as default.

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Credit Ratings
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Anyone wants to have insurance in Bond
Holdings?Credit Default Swaps

• CDS is a bilateral contract that provides the
  buyer of the CDS insurance against the risk of
  default by a particular company.
• Market for products in 2004

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Who were the end users of CDS?
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Credit Default Swap spread (the premium)

• The Credit Default Spread is quoted in Basis
  Points per annum.
• Paid Quarterly in arrears

Buyer of CDS pays quarterly
1 yr
Trade date
Seller of CDS protection receives quarterly
payments
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Credit Default Swap spread (the premium)

• For example, a CDS on Ford Motor Credit is quoted
  at 80 bps per annum on a notional 10 million USD.
  The protection buyer will pay -

Notional amount x (Basis Points x days / Day
Base) Quarterly payment
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Credit default Swaps- Credit Events.

• For a Credit Default Swap payment to be made, a
  credit event on a reference entitys asset has to
  have happened. Payment is contingent on the
  credit event.
• What is a credit event ?
• Bankruptcy
• Failure to pay
• Restructuring
• Repayment Acceleration on Default (cross default
  clauses)
• Repudiation

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Short-tour of the Fixed Income Information in
3000Xtra

• What data in Reuters 3000 Xtra is relevant to
  CDS?
• CDSINDEX
• GFIINDEX
• HSBC/CDS
• TRACX (Morgan Stanley)
• General
• BONDS (F3)
• Latest ratings with history and news to analyse
  credit risk, for example RRS0001 shows the
  ratings history from full range of ratings
  agencies AAA shows credit news alerts
• ltRTRTSY1gt (US composite. ltRTRINDEXgt has all of
  the composite pages)
• ltRTRTSY2gt (Off the runs)
• ltRTRSWP1gt (Interest rate SWAPs)
• ltCURVESgt (F3)

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Customize your CDS Screen (CDS Data, Yield
Curve, News)
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Pricing Credit Default Swaps.

• There are two approaches
• Valuation by proxy.
• Mathematical approach.

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Search Credit Default Swap Model from Getgoing
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Credit Default Swap Model Hutchison CDS Price
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Search CDS from Equity Reference Name
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Search CDS from Equity Reference Name
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Search CDS from Bond ID
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Search CDS Prices from Major Contributors
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Hutchison Credit Curve
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Correlation CDS Share Prices ?
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http//showcase.session.rservices.com
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Credit Default Swap

• Use the Credit Default Swap model to locate a
  reference credit and analyse the spread history
  of the credit.  You can compare a reference
  credit to other reference credits in a peer
  group.  You can also compare a reference credit
  to the underlying stock, or to a bond asset swap
  spread.  The Credit Default Swap model presents
  the information with the best company and credit
  default swap (CDS) news in one display.
• Features
• View intra-day updates of bid, offer, and dealt
  CDS spreads from GFI
• View the GFI history of a CDS bid and ask spread
• View intra-day updates of bid and offer CDS
  spreads from other contributors, such as HSBL and
  Credit Trade
• View credit reference spreads for over 1,800
  entities held in the Reuters database from a
  number of contributors, including GFI
• Compare the performance of a CDS spread to the
  equity price over time in a graph
• Compare a CDS spread against two others CDS
  spreads over time in a rebase graph
• Compare the history of the CDS spread against the
  asset swap spread of the selected bond
• Identify news stories linked to historic events
  in the history of a CDS and related equity 
• Find a specific reference entity from a bond or
  equity, or from a sector or region
• View all the related issues of a reference credit
  
• View all the details of the reference credit
• View the best company and CDS news in one display
  
• View the price and volatility information on the
  underlying stock
• View asset swap and benchmark spreads for related
  bonds

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CDS Analysis Model
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CDS Analysis

• CDS Analysis model allows you to price a credit
  default swap (CDS), and value an existing CDS.
• Features 
• CDS Analysis model calculates
• CDS spread and premium
• a default probability curve from the CDS spreads
• a CDS spread curve from the contributed spreads
  using credit risk models
• asset swap spreads from the bonds closest to the
  CDS maturity
• DV01 for the CDS spread and the risk free zero
  curve
• valuation of existing CDS
• You can
• compare CDS spreads against asset swap spreads
• price using the Cox, Ingersoll, and Ross model or
  a credit event probability curve
• calibrate the credit risk models from CDS spreads
  or a risky curve
• define a risky curve from interest rate swap
  prices or related straight bonds
• use your own zero curve for the risk free curve
• view the data in a chart

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Issuer Model
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• Features and benefits
• Using the Issuer worksheet you can
• Display information on a selected issuer of
  stocks and/or bonds.
• View information on the sector in which the
  company is active.
• View a summary of the latest company report.
• View stock/bond listings and Issuer level ratings
  
• Move to a related worksheet giving further
  information on a selected stock or bond.   
• The Issuer worksheet provides information about
  an issuer of stocks and/or bonds, including the
  sector in which the company is active, selected
  facts from the latest company report, company
  news, listings with all issued stocks and bonds,
  and issuer-level rating, where available. 
•  

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Bond Credit Model
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• Features and benefits
• The Bond Credit worksheet provides the full
  picture on the credit risk of a bond or an issuer
  through the integrated display of relevant news,
  real-time and additional research data. Credit
  information as well as actions and assignment
  notices from specific rating agencies is
  available at the issue and issuer levels. The
  worksheet also gives an overview of an issuer's
  credit history.
• With this worksheet you can
• Obtain an overview of credit news and current and
  historic rating information on an issuer and
  issue level.
• View all live bonds from the same issuer.
• Obtain rating actions and credit assignment
  notices from specific rating agencies such as SP
  Creditwire.
• Obtain credit spreads contributed by JP Morgan.
• The Bond Credit worksheet gives you
• The full picture on the credit risk of a bond or
  an issuer through the integrated display of
  relevant news, real time, historic and additional
  research data.

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Power Plus Pro - FI

• Building Fixed Income spreadsheet and data
  downloading (Adfin Functions)

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Q A

• DAVID_HKU_at_YAHOO.COM