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Credit Derivatives

Courses In This Course

Although it was possible to isolate the credit risk on debt (by using asset swaps), it was almost impossible to reduce it – until the advent of credit derivatives in the 1990s. Credit derivatives allow market participants to pay or receive a credit spread without the need for any underlying debt position. The holder of a “risky” instrument can reduce credit risk by buying protection against default.

 

In the early days of the credit derivatives market, the focus was on offloading the credit risk exposure in bank loan books by offering investors a return in exchange for taking on the credit risk. The instruments offered were often complex structures combining credit derivatives with securitization. However, simpler trades referencing particular names (single-name credit default swaps) came to represent the bedrock of the market by the turn of the century. The market developed rapidly in terms of size, product types, and complexity, with credit derivatives coming close in 2007 to surpassing FX derivatives as the second largest segment of the global OTC derivatives market. However, volumes declined substantially following the financial crisis and developments such as the use of trade compression techniques and the shift toward central clearing (which contributed to an increase in netting). The events of the crisis, and subsequent regulatory and market developments, made clear the necessity for all market participants to have a thorough understanding of credit derivatives.

Objectives

Topics covered in this course include:

Credit as an asset class

The evolution and development of the credit derivatives market

The key features and trading practices associated with single-name CDS

The mechanics of CDS index products

CDS valuation

The CDS documentation framework

The use of auction settlement to determine recovery rates

Other types of credit derivatives, including recovery products, portfolio products, and synthetic CDOs

 

The course also includes an interactive scenario that uses two hypothetical CDS trades to describe how credit derivatives can be used in practice.

Learner Profile

This course is designed for:

  •    CREDIT DERIVATIVES - AN INTRODUCTION

    Overview

    Credit derivatives allow one party to transfer an asset's credit risk to another party without transferring ownership of the underlying asset. This course outlines the basics of credit derivatives and examines the structure of a basic credit derivatives trade, known as a credit default swap (CDS). Other topics covered include the development of the market pre- and post-financial crisis, and the risks associated with undertaking credit derivatives transactions.

    Course Duration

    75 mins

    Prerequisite Knowledge

    Derivatives – Markets

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  •    CREDIT DERIVATIVES - SINGLE-NAME CDS

    Overview

    Single-name credit default swaps are comparatively simple instruments when compared with the complex and opaque structures that once adorned the credit derivatives market. This course outlines the key features and trading practices surrounding these instruments.

    Course Duration

    60 mins

    Prerequisite Knowledge

    Credit Derivatives – An Introduction

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  •    CREDIT DERIVATIVES - CDS INDICES

    Overview

    Index swaps allow participants to increase or decrease general credit exposure, although the creation of credit indices has always been directly connected to the trading of index products. There is significantly more liquidity in these products than in single-name CDS transactions. This course looks at the construction of credit indices, the mechanics of index swaps, and the market environment.

    Course Duration

    50 mins

    Prerequisite Knowledge

    Credit Derivatives – Single-Name CDS

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  •    CREDIT DERIVATIVES - CDS VALUATION

    Overview

    CDS pricing is theoretically straightforward – whatever is paid as protection premium should be offset by the expected gains from contingent default payments. However, calculating the present values of these payments involves more subtle assumptions about default probabilities and recovery rates. There must also be some method for calculating the fair value of the upfront payments generated by differences between theoretical spreads and fixed coupons.

     

    This course outlines the key calculations in CDS pricing and shows how valuation has coalesced around standard pricing models and simplified assumptions.

    Course Duration

    60 mins

    Prerequisite Knowledge

    Credit Derivatives – Single-Name CDS

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  •    CREDIT DERIVATIVES - CDS DOCUMENTATION

       & SETTLEMENT

    Overview

    A well-understood and widely-accepted CDS documentation framework and a robust credit event auction system have evolved under the auspices of ISDA. This framework, periodically adjusting in response to market challenges, has standardized trading practices and settlements.

     

    This course outlines the key features of the ISDA documentation framework and shows how auction settlement is used to determine recovery rates.

    Course Duration

    60 mins

    Prerequisite Knowledge

    Credit Derivatives – Single-Name CDS

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  •    CREDIT DERIVATIVES – VARIATIONS

    Overview

    This course explores the key relationship between different credit products, and introduces some of the lesser-known variations in the credit derivatives market.

    Course Duration

    90 mins

    Prerequisite Knowledge

    Credit Derivatives – Documentation & Settlement

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  •    SCENARIO - CDS RELATIVE VALUE TRADING

    Overview

    This scenario focuses on two hypothetical CDS relative value trades (a pairs trade and a curve trade), using them to show you how credit derivatives can be applied in practice. At different points in the scenario, you will be asked to perform calculations or look at potential alternative actions for the trader involved. At the end of the scenario, you will have a solid understanding of how CDS trades such as those described can be constructed and evaluated.

    Course Duration

    45 mins

    Prerequisite Knowledge

    A solid knowledge of credit derivatives and the associated pricing principles is assumed. In particular, you should be familiar with standardized single-name CDS transactions.

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