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Credit Derivatives: Mechanics, Analysis, Applications and Risk Management

Duration: 2 days
  • Credit Default Swaps
  • Basket default Swaps
  • Total Return Swaps
  • Credit Options and Credit Spread Options
  • Credit Linked Notes and CDOs
  • Hedging Corporate and Sovereign Risk
  • Managing Risks of Credit Derivatives
The objective of this seminar is to give you a good understanding of the mechanics, pricing, risk analysis and applications of credit derivatives and structured credit products.

We start with a brief introduction to credit derivatives and with an overview of the market for these instruments.

We then look in detail into the most important type of credit derivative: Credit default swaps (CDS). We give a thorough explanation of the mechanics of these instruments, and we give examples of different types of CDS, including single-name and basket CDS. We explain how the instruments are priced, form a theoretical as well as a market perspective, and we discuss the importance of market indexes such as iTraxx. Using practical case studies, we also present, explain and discuss how CDS are used for the hedging of corporate and sovereign default risk, spread risk, and other types of credit risks.

Further, we explain the mechanics and pricing of “total return swaps”, “credit options” and credit spread options”. We demonstrate the applications of these instruments with practical case studies. We also look at how credit default swaps and other credit derivatives are used as building blocks in creating structured and leveraged credit products, such as credit linked notes and synthetic CDO’s.

Finally, we turn to look at how the explicit and implicit risks of using credit derivatives can be assessed and managed. We explain and demonstrate how credit and spread risk can be measured and hedged. We also give an in-depth explanation of how counterparty risk of credit derivatives can be measured and how it can be managed using collateral agreements, economic capital allocation, risk transfer and other techniques. We also discuss the move towards increased standardization and centralized clearing of credit derivatives.

Day One

09.00 - 09.15 Welcome and Introduction

09.15 - 12.00 Introduction and Overview

  • Credit Derivatives and their Predecessors
  • Historical Development
  • Overview of Instruments and Markets

Credit Default Swaps

  • Definitions and Mechanics
  • Differences/Similarities with Asset Swaps
  • Types and Mechanics
    • Single-name corporate CDS
    • Sovereign CDS
    • Basket CDS
  • Credit Events
    • Bankruptcy
    • Failure to pay
    • Restructuring
    • Moratorium/Repudiation
    • …….
  • Case Studies: Credit Events

12.00 - 13.00 Lunch

13.00 - 16.30 Credit Default Swaps (Continued)

  • Settlement Methods
    • Cash settlement
    • ISDA auction procedure
    • Physical delivery
  • Pricing of CDS
    • Estimating the theoretical price
    • Backing out PD form quoted spreads
    • Pricing basket CDS
  • The iTraxx Index
    • Construction
    • Components
    • Applications
    • A live sight-seeing tour of the iTraxx index!
  • CDS Applications (Case Studies)
    • Hedging corporate credit risk with single name CDS
    • Hedging sovereign risk
    • Hedging portfolio credit risk
    • Hedging spread risk
  • Exercises

Day Two

09.00 - 09.15 Recap

09.15 - 12.00 Equity Default Swaps

  • What is an Equity Default Swap?
  • Differences between EDS and CDS
  • Carry Trades with CDS and EDS
  • Small Exercise

Total Return Swaps

  • Mechanics and Applications of TR Swaps
  • Pricing of TR Swaps
  • Case Study
    • Using TR swap to create synthetic exposure to leveraged loan portfolio
  • Small Exercise

Credit Options

  • Credit Spread Forwards, Calls and Puts
  • Credit Spread Trading Strategies
  • Case Studies: Hedging Spread Risk
  • Small Exercise

12.00 - 13.00 Lunch

13.00 - 16.30 Credit-Linked Notes and CDOs

  • What is a Credit-Linked Note
  • Examples of Credit-Linked Notes
  • Leveraged Credit Linked Notes
  • Case Study
  • Credit –Linked Notes as Building Blocks in Synthetic CDOs
  • Valuation of Credit-Linked Notes and Synthetic CDOs
  • Small Exercises

Risk Management of Credit Derivatives

  • Explicit Risks
    • Credit risk of underlying
    • Spread risk
  • Implicit Risks
    • Counterparty risk
    • Operational risk
  • The Move towards Standardization and Centralized Clearing

Evaluation and Termination of the Seminar