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FRM(Term V) 2013
Dr. Kulbir Singh
IMT-Nagpur
Market: Credit Derivatives & CDS
Net Net
Buyers Sellers
Credit
Premium/
Spreads
• Expressed in bps
• Market Maker (bankers) quote Credit spread in bid-offer basis point
• Eg. Bid - 250bps [2.5% of principal/yr] and Offer - 260 bps [2.6% of principal/yr]
• Most popular – payments made quarterly and in arrears
Credit
Event
2009 2010 2011 2012 2013 2014
June 01
Mar 01 Mar 01 Mar 01 Mar 01 Mar 01 Mar 01
$900,000 $900,000 $900,000 $900,000 $900,000
$225,000
Source:http://www.youtube.com/watch?v=cmUXTFggIa0
Dr. Kulbir Singh (FRM) 2013 IMT-N 12
Credit Default Swap (CDS)
Source:http://www.youtube.com/watch?v=cmUXTFggIa0
Dr. Kulbir Singh (FRM) 2013 IMT-N 13
CDS Numerical: HW
• Chapter 23, Jorion
– Example 23.3, 23.4, & 23.6
• Extra Numerical (will be used for testing skills
in exam)
– Numerical Set: Credit Derivatives …Handout
distributed in the class
Source:http://www.youtube.com/watch?v=cmUXTFggIa0
15
Dr. Kulbir Singh (FRM) 2013 IMT-N
Valuation of Credit Default Swaps (CDS)
• Mid-Market CDS spreads (av. of bid & offer CDS spread) can be calculated
fro default probability estimates
• Suppose the PD of ref. entity defaulting a year conditional on no earlier
default is 2%.
• Table below shows survival probabilities and unconditional PD (i.e. PD as
seen at time zero) for each of 5 years.
Table #1
Table #2
Table #3
Table #4