Asset Pricing

CDS/CLN

Credit Derivatives

  • A credit derivative product is a derivative product that separates credit risk from underlying assets
  • Guarantor Buyer transfer credit risk and pays fee, Guarantee seller receives credit risk and fee

Function

By diversifying concentrated credit risk to various economic entities, stabilization of the financial system can be achieved

Issuers point of view
  • Increase the efficiency of credit risk management: transfer credit risk through guarantee purchase, reduce credit risk exposure
  • Maintain relationships with clients: No need to sell assets
  • Revenue creation through various product design and investment: CLN, synthetic CDO, Forward Starting CDS and etc.
Market efficient point of view

Increase liquidity of reference assets: Credit derivative transactions may occur more than transactions for physical(real) assets (loans, bonds)

Investors’ point of view

Various maturity and yield composite product can be design to meet risk-return structures of investors

Risk

  • Concentration of credit risk by excessive guarantee position - collapse of Hedge fund and investment bank
  • Complex product design makes it difficult to identify overall risk - difficult to calculate market prices for structured products

Credit Derivatives Types

inform of Type, Descriptio
Type Description
CDS (Credit Default Swap) A contract that Guarantor Buyer transfer credit risk and pays fee, Guarantee seller receives credit risk and fee
Basket CDS A contract that Guarantor Buyer transfer credit risk of a particular trench and pays fee, Guarantee seller receives credit risk of a particular trench and fee
Credit Spread Option CDS Spread based underlying option contract
Forward Starting CDS CDS Spread based underlying forward contract
CLN (Credit Linked Note) Bonds with CDS
Synthetic CDO instead of transferring underlying assets, a product that has structure of CDO by synthetic CDS
CDS Index Credit Index to tract down CDS Spread
Leverage Skew Swap Products traded basis of the differences between Index Spread and Intrinsic Spread
TRS Trade that exchange Total return of Bonds and base set rate + exchange of spread
(R) MBS Securitized mortgage-backed loans
CMBS Securitized commercial mortgage-backed loans
CLO Securitized Leveraged Loan (Junk Rating Loan)

Credit Derivatives Pricing Model

inform of Type, Descriptio
Type Descriptio
Single CDS Reduced Form Model (Hazard Rate Model)
Basket CDS 1-factor Gaussian Copular model
CDO LHP Model

Credit DLS/CLN = BOND + CDS

inform of Credit DLS/CLN = BOND + CDS

CDS-CDS BTB Trade, ABCP/ABS Issuance

inform of CDS-CDS BTB Trade, ABCP/ABS Issuance