CREDIT DEFAULT

SWAPS
Ptd By.
Ami
Abhishek Kamat
Ajaysingh
Chaitra B
Ravi Kumar
Vishwanath Sukhasare

Credit Derivatives

These are contracts where the payoff

depends on the credit worthiness of one or
more countries or companies.

Banks Buyers of Credit protection

Insurance companies Sellers of Credit
protection

Credit Default Swaps

(CDS)
A contract that provides insurance against
the risk of a default by a particular
company.
The company is known as reference entity
and the default, a credit event.

Contd
The buyer of insurance obtains the right to
sell bonds issued by the company for their
face value when the credit event occurs and
vicee versa.
The total face value of the bond is called
CDSs notional principal.

Contd

Buyer of CDS makes periodic payments.

Settlement in case of default is by physical

delivery or cash settlement.

Default
Protection
Buyer

Default
Protection
Seller

Example
Contract entered into for a 5-year CDS on
March 1,2009.
Notional principal $100 million
90 basis points paid annually
Credit event on June 1, 2012
Settled by physical delivery or cash
Accrual payment made

Contd
CDS Spread
Different bid and offer price
Standard maturity on standard dates

CDS Forwards and Options

A forward CDS is an obligation to buy or
sell a particular CDS on a particular
reference entity at a particular future time
T.
A CDS option is an option to buy or sell a
particular CDS on a particular reference
entity at a particular future time T.

Total Return Swaps

It is an agreement to exchange the total

return on a bond (or any portfolio of assets)
for LIBOR plus a spread.

Total Return
Payer

Total
Return
receiver

Credit Spread Option

A financial derivative contract that transfers credit
risk from one party to another. An initial premium is
paid by the buyer in exchange for potential cash
flowsif a given credit spread changes from its
current level.
The buyer of a credit spread option will receive
cash flows if the credit spread between two specific
benchmarks widens or narrows. Credit spread
options come in the form of both calls and puts,
allowing both long and short credit positions.

A credit spread option is an option on a

particular borrower's credit spread. The credit
spread is the difference between the yield on
the borrower's debt (in the loan or bond
market) and the yield on Treasury debt of the
same maturity. Since Treasury debt is free of
any default risk, the credit spread provides a
measure of the premium in yield investors
require to compensate for the risk of default.

The major advantage of credit spread options

over credit swaps is that a defined credit event
does not have to be specified at the start of the
transaction.

A significant drawback is that credit spread

options are difficult to price and hedge. There is
no shortage of theoretical models for pricing
these options, however, these models can be
very complicated and it is difficult to develop
workable implementations. In many instances,
market participants can achieve their
objectives through the use of credit swaps.

HOW CREDIT SPREAD OPTIONS WORK

Credit spread options capture spread
changes in a reference asset that are
independent of changes in the general interest
rate yield curve. These options are normally
written on marketable debt securities. They can
be viewed as credit swaps that stipulate spread
widening (credit spread put) or spread
narrowing (credit spread call) as the credit
event.

A credit spread put is a put option whose payoff

increases as the yield spread on a specified bond
rises above a specified spread X. X is called the
strike spread. A credit spread call is a call option
whose payoff increases as the yield spread falls
further below X. Holding constant the yield on
default-risk-free debt, the reduction in yield spread
causes the yield of the risky debt obligation to fall,
and the value of the risky debt to rise. Credit spread
options usually have times to expiration of between
six months and two years. They can be settled in
cash or through delivery of the underlying bond.

Collateralized Debt
Obligation
Definition -CDO's, or Collateralized Debt
Obligations, are sophisticated financial
tools, that repackage individual loans into a
product These packages consist of auto
loans, credit card debt, or corporate debt.
are
a
type
ofstructuredasset-backed
security(ABS)

The first CDO was issued in 1987 by Drexel

Burnham LambertInc.
Anasset-backed
securitybacked
by
thereceivablesonloans,bonds,
or
otherdebt.
Bankspackage andselltheir receivables on
debt toinvestorsin order to reduce
theriskoflossdue todefault.
CDOs securities are split into different risk
classes, ortranches- Senior tranche,
junior tranche and Equity tranche.

Returnson CDOs are paid in tranches; that

is, the individual loans backing each CDO
have different levels of risk, and investors
are paid out according to the level of risk
they have acquired.
Banks
offer
higherinterest
ratesto
investors willing to buy CDOs backed by
higher-risk loans. And lower for those who
acquire lower risk involved CDO.
CDO is a promise to pay cash flows to
investors in a prescribed sequence, based
on how much cash flow the CDO collects
from the pool of bonds or other assets it

How it works

Loans
Bonds
&
Assets

Bank

Portfolio of
Receivables

CDO

Investors

Parties Involved
Investors
Underwriter
The asset manager
The trustee and collateral administrator

List of Banks Offering CDO

ATC Capital Markets
Bank of New York Mellon
BNP ParibasSecurities Services
Citi Bank
Deutsche Bank
Equity Trust
Intertrust Group
HSBC
LaSalle Bank
Sanne Trust
State Street Corporation
US Bank
Wells Fargo
Wilmington Trust

Thank You..