Richard Bruyere – Credit Derivates & Structured Credit

Foreword.

Introduction.

1 Credit Risk and the Emergence of Credit Derivatives.

1.1 Credit Risk.

1.1.1 Definition and Typology of Credit Risk.

1.1.2 Characteristics of Credit Risk.

1.1.3 The Importance of Credit Risk in Capital Markets.

1.2 Assessment and Measurements of Credit Risk.

1.2.1 Bank Capital Adequacy Standards (Basel I).

1.2.2 Credit Risk Analyzed by Rating Agencies.

1.2.3 Credit Risk Measured in the Financial Markets: Credit Spread.

1.3 Traditional Methods of Credit Risk Management and the Emergence of Credit Derivatives.

1.3.1 Traditional Methods for Managing Credit Risk (Issuer Risk).

1.3.2 Counterparty Risk Management in Derivatives Markets.

1.3.3 Emergence and Advantages of Credit Derivatives.

2 Typology of Credit Derivatives and their Main Applications.

2.1 Credit Default Swaps.

2.1.1 Description of Credit Default Swaps.

2.1.2 Comparison Between the CDS Market and the Cash Market: Basis.

2.1.3 Main Variations on CDSs.

2.2 Other Credit Derivatives.

2.2.1 Credit Spread Derivatives.

2.2.2 Synthetic Replication Products.

2.3 Main applications of Credit Derivatives.

2.3.1 Applications for Institutional Investors and Other Capital Market players.

2.3.2 Credit Derivative Applications in Bank Management.

2.3.3 Credit Derivative Applications for Corporates.

3 Second-Generation Credit Derivatives.

3.1 Basket Credit Default Swaps.

3.1.1 First-to-Default Credit Swaps.

3.1.2 Concrete Example.

3.1.3 Extension of the First-to-Default Principle: i to j-to-Default Products.

3.2 Hybrid Products.

3.2.1 Capital-Guaranteed/Protected Products.

3.2.2 Other Hybrid Products.

3.2.3 Concrete Example of a Transaction.

3.3 Credit Indices.

3.3.1 Introduction to Credit Indices.

3.3.2 Credit Index Mechanism, Pricing and Construction.

3.3.3 iTraxx Indices: a True Innovation to Benefit Investors.

4 Collateralized Debt Obligations.

4.1 Cash-Flow CDOs (Arbitrage CBOs and CLOs).

4.1.1 Origin of Arbitrage CBOs/CLOs.

4.1.2 Description of a CDO Structure.

4.1.3 Overview of the CBO/CLO Market and Recent Developments.

4.2 Balance Sheet-Driven CDOs.

4.2.1 Securitization of Bank Loans.

4.2.2 The Impact of Credit Derivatives: Synthetic CLOs.

4.2.3 Balance Sheet-Driven CDOs and Regulatory Arbitrage.

4.3 Arbitrage-Driven Synthetic CDOs.

4.3.1 The First Arbitrage-Driven Synthetic CDOs.

4.3.2 Actively Managed Arbitrage-Driven Synthetic CDOs.

4.3.3 On-Demand CDOs (Correlation Products).

5 The Credit Derivatives and Structured Credit Products Market.

5.1 Overview of the Market.

5.1.1 Main Stages in the Development of the Credit Derivatives Market.

5.1.2 Size, Growth and Structure of the Credit Derivatives Market.

5.1.3 Size, Growth and Structure of the CDO Market.

5.2 Main Players.

5.2.1 Banks.

5.2.2 Insurance, Reinsurance Companies and Financial Guarantors.

5.2.3 Hedge Funds and Traditional Asset Managers.

5.2.4 Corporates.

5.3 At the Heart of the Market: The Investment Banks.

5.3.1 Position of the Investment Banks in the Credit Derivatives Market.

5.3.2 Position of the Investment Banks in the CDO Market.

5.3.3 Functions and Organization of Investment Banks.

6 Pricing Models for Credit Derivatives.

6.1 Structural Models.

6.1.1 The Black–Scholes Option Pricing Model.

6.1.2 Merton’s Structural Model of Default Risk (1976).

6.1.3 Limitations and Extensions of the Merton Model (1976).

6.1.4 Pricing and Hedging Credit Derivatives in Structural Models.

6.2 Reduced-Form Models.

6.2.1 Hazard Rate and Credit Spreads.

6.2.2 Pricing and Hedging of Credit Derivatives in Reduced-Form Models.

6.2.3 Accounting for the Volatility of Credit Spreads.

6.2.4 Accounting for Interest Rate Risk.

6.3 Pricing Models for Multi-Name Credit Derivatives.

6.3.1 Correlation, Dependence and Copulas.

6.3.2 The Gaussian Copula Model.

6.3.3 Multi-Asset Structural Models.

6.3.4 Dependent Defaults in Reduced-Form Models.

6.4 Discussion.

6.4.1 Comparing Structural and Reduced-Form Modeling Approaches.

6.4.2 Complex Models, Sparse Data Sets.

6.4.3 Stand-alone Pricing Versus Marginal Pricing.

7 The Impact of the Development in Credit Derivatives.

7.1 The Impact of the Growth in Credit Derivatives on Banking Institutions.

7.1.1 Far-Reaching Changes in the Capital Markets.

7.1.2 An Economic Approach to Credit Risk Management.

7.1.3 Overview of the Banks of the Twenty-First Century: the Effect of Credit Derivatives on Banks’ Strategy, Organization and Culture.

7.2 Credit Derivatives and Financial Regulations.

7.2.1 Credit Derivatives and the New Basel II Regulations.

7.2.2 Credit Derivatives and the Instability of the Financial System.

7.2.3 A More Rounded Picture.

7.3 Credit Derivatives: A Financial Revolution?

7.3.1 Introduction to Particle Finance Theory.

7.3.2 Implications of ‘Particle Finance Theory’ for the Capital Markets.

7.3.3 An Innovation that Heralds Others.

Conclusion.

References.

Further Reading.

Index.

About the Author