Credit Derivatives -- Contents -- Preface to the First Edition -- Preface to the Second Edition -- Acknowledgements -- Disclaimer -- Table of Spreadsheet Examples and Software -- About the Author -- PART I CREDIT BACKGROUND AND CREDIT DERIVATIVES -- 1 Credit Debt and Other Traditional Credit Instruments -- 1.1 Bonds and Loans -- Libor Rates and Swaps -- 'REPO' and General Collateral Rates -- 1.1.1 Bonds and Loans -- 1.1.2 BBA Libor and Swaps -- 1.1.3 Collateralised Lending and Repo -- 1.1.4 Repo as a Credit Derivative -- 1.2 Credit Debt Versus 'Risk-Free' Debt -- 1.3 Issue Documents, Seniority and the Recovery Process -- 1.3.1 Issue Documents and Default -- 1.3.2 Claim Amount -- 1.3.3 The Recovery Process and Recovery Amount -- 1.3.4 Sovereign versus Corporate Debt -- 1.4 Valuation, Yield and Spread -- 1.5 Buying Risk -- 1.6 Marking to Market, Marking to Model and Reserves -- 1.7 The 'Credit Crunch' and Correlation -- 1.8 Parties Involved in the Credit Markets and Key Terminology -- 2 Default and Recovery Data -- Transition Matrices -- Historical Pricing -- 2.1 Recovery: Ultimate and Market-Value-Based Recovery -- 2.1.1 Ultimate Recovery -- 2.1.2 Market Recovery -- 2.1.3 Recovery Rates and Industry Sector -- 2.1.4 Recovery and Default Rates and the Economic Cycle -- 2.1.5 Modelling Recovery Rates -- 2.2 Default Rates: Rating and Other Factors -- 2.3 Transition Matrices -- 2.4 'Measures' and Transition Matrix-Based Pricing -- 2.5 Spread Jumps and Spread Volatility Derived from Transition Matrices -- 2.6 Adjusting Transition Matrices -- 3 Asset Swaps and Asset Swap Spread -- z-Spread -- 3.1 'Par-Par' Asset Swap Contracts -- 3.1.1 Contract Description and Hedging -- 3.1.2 Hedging -- 3.1.3 Default of the Reference Name -- 3.2 Asset Swap Spread -- 3.3 Maturity and z-Spread -- 3.4 Callable Asset Swaps -- 'Perfect' Asset Swaps.

3.4.1 Callable Asset Swaps -- 3.4.2 'Perfect' Asset Swaps -- 3.5 A Bond Spread Model -- 4 Liquidity, the Credit Pyramid and Market Data -- 4.1 Bond Liquidity -- 4.2 The Credit Pyramid -- 4.3 Engineered and Survey Data -- 4.3.1 Survey Data -- 4.3.2 Engineered Data -- 4.4 Spread and Rating -- 5 Traditional Counterparty Risk Management -- 5.1 Vetting -- 5.2 Collateralisation and Netting -- 5.3 Additional Counterparty Requirements for Credit Derivative Counterparties -- 5.4 Internal Capital Charge -- 6 Credit Portfolios and Portfolio Risk -- 6.1 VaR and counterpartyVaR -- 6.2 Distribution of Forward Values of a Credit Bond -- 6.3 Correlation and the Multi-factor Normal (Gaussian) Distribution -- 6.4 Correlation and the Correlation Matrix -- 7 Introduction to Credit Derivatives -- 7.1 Products and Users -- 7.1.1 'Traditional' Credit Instruments -- 7.1.2 'Single Name' Credit Derivatives -- 7.1.3 Credit-Linked Notes -- 7.1.4 Portfolio Credit Derivatives -- 7.2 Market Participants and Market Growth -- PART II CREDIT DEFAULT SWAPS AND OTHER SINGLE NAME PRODUCTS -- 8 Credit Default Swaps -- Product Description and Simple Applications -- 8.1 CDS Product Definition -- 8.1.1 Contract Description and Example -- 8.1.2 Market CDS Quotes and Premium Payment -- 8.1.3 Related Products -- 8.1.4 CDS on Loans: LCDS -- 8.2 Documentation -- 8.2.1 ISDA Documentation and Insurance Contract Differences -- 8.2.2 Reference Obligations, 'Markit RED' and CreditIDs -- 8.3 Credit Triggers for Credit Derivatives -- 8.3.1 Credit Events -- 8.3.2 Restructuring -- 8.4 CDS Applications and Elementary Strategies -- 8.4.1 Single Names -- 8.4.2 Sector/Portfolio Trades -- 8.4.3 Income Generation -- 8.4.4 Regulatory Capital Reduction -- 8.5 Counterparty Risk: PFE for CDS -- 8.6 CDS Trading Desk -- 8.6.1 Mechanics of Transacting a CDS Deal -- 8.6.2 Trade Monitoring, Credit Events, Unwinds.

8.6.3 CDS Desk Interactions and Organisation -- 8.7 CDS Contract and Convention Changes 2009 -- 8.7.1 Credit Derivatives: Review -- 8.7.2 Overview of Recent Changes -- 8.7.3 Contract Changes -- 8.7.4 Convention Changes -- 9 Valuation and Risk: Basic Concepts and the Default and Recovery Model -- 9.1 The Fundamental Credit Arbitrage - Repo Cost -- 9.2 Default and Recovery Model -- Claim Amount -- 9.2.1 Claim Amount -- 9.2.2 Recovery Modelling -- 9.2.3 Hazard (Default) Rate Model -- 9.2.4 Choice of Hazard Rate Function/Interpolation Process -- 9.3 Deterministic Default Rate Model -- 9.3.1 CDS Valuation -- 9.3.2 Accrued Interest and the Delivery Option -- 9.3.3 CDS Under Constant Hazard Rate -- 9.3.4 Up-front Premiums -- 9.3.5 Bond Valuation -- 9.3.6 Bond Price Under a Constant Hazard Rate -- 9.3.7 Limiting Cases of the Bond Price -- 9.3.8 Risky Zero Coupon Bonds -- 9.3.9 CDS and Bond Sensitivities -- 9.4 Stochastic Default Rate Model -- Hazard and Pseudo-Hazard Rates -- 9.5 Calibration to Market Data -- 9.5.1 Calibrating to CDSs and to Bonds -- 9.5.2 Implied Hazard Rates -- 9.5.3 Calibrating to Bonds: Multiple Solutions for the Hazard Rate -- 9.5.4 Calibrating to Bonds: Implied Recovery and Hazard Rates -- 9.5.5 Implied Hazard Rate Curve and No-Arbitrage -- 9.5.6 Syndicated Loans -- 9.6 CDS Data/Sources -- 9.6.1 Survey Data -- 9.6.2 Data Engineering -- 9.7 Model Errors and Tests -- 9.7.1 Recovery Assumption -- 9.7.2 Interest and Hazard Rate Correlation -- 9.7.3 Reference Name and Counterparty Hazard Rate Correlation -- 9.7.4 Interpolation Assumptions, and the Pseudo-Hazard Rate versus Stochastic Hazard Rate -- 9.8 CDS Risk Factors -- Reserves and Model Risk -- 9.8.1 Captured and Hidden Risks -- 9.8.2 Limits -- 9.8.3 Reserves against Implementation Errors -- 9.8.4 Model Reserves -- 10 CDS Deal Examples.

10.1 A CDS Hedged Against Another CDS -- 10.1.1 Cross-Currency Default Swap Pricing and Hedging -- 10.1.2 Back-to-Back Trades, Default Event Hedges and Curve Trades -- 10.1.3 Hedging Both Credit Event and Spread Risk Simultaneously -- 10.1.4 Seniority Mismatch -- 10.1.5 Trade Level Hedging and Book Basis Hedging -- 10.2 Introduction to Bond Hedging -- 10.2.1 Default Event Hedging -- 10.2.2 Spread Hedging -- 10.2.3 Convertible Bonds and Equity Risk -- 10.3 Hedge and Credit Event Examples -- 11 CDS/Bond Basis Trading -- 11.1 Bond Versus CDS: Liquidity -- 11.2 Bond Repo Cost -- 11.3 Bond Spread Measurement - z-Spread not Asset Swap Spread -- 11.4 Bond Price Impact -- 11.5 Embedded Options in Bonds and Loans -- 11.6 Delivery Option In CDSs -- 11.7 Payoff of Par -- 11.8 Trigger Event Differences -- 11.9 Embedded Repo Option -- 11.10 Putting it All Together -- 12 Forward CDS -- Back-to-Back CDS, Mark to Market and CDS Unwind -- 12.1 Forward CDS -- 12.2 Mark-to-Market and Back-to-Back CDS -- 12.3 Unwind Calculation -- Off-Market Trade Valuation and Hedging -- 12.4 'Double-Trigger CDS' -- 13 Credit-Linked Notes -- 13.1 CLN Set-Up -- Counterparty or Collateral Risk -- 13.2 Embedded Swaps and Options -- 13.3 Costs -- 13.4 Applications -- 13.5 CLN Pricing -- 13.5.1 Basic Pricing -- 13.5.2 CLN Pricing Model -- 13.6 Capital Guaranteed Note -- 14 Digital or 'Fixed Recovery' CDS -- 14.1 Product Description -- 14.2 Pricing, Hedging, Valuation and Risk Calculations -- 14.2.1 Simple Pricing -- 14.2.2 Recovery Assumptions -- 14.2.3 Valuation and Hedging -- 14.3 Trigger Event Differences -- 15 Spread Options, Callable/Puttable Bonds, Callable Asset Swaps, Callable Default Swaps -- 15.1 Product Definitions -- 15.1.1 Vanilla Spread Options and Variations -- 15.1.2 Related Embedded Products -- 15.1.3 Bond Price Options -- 15.1.4 Applications.

15.2 Model Alternatives and a Stochastic Default Rate Model for Spread Option Pricing -- 15.2.1 Model Approaches -- 15.2.2 Hazard Rate Tree -- 15.2.3 Callable High Yield Bonds -- 15.3 Sensitivities and Hedging -- 16 Total Return Swaps -- 16.1 Product Definition and Examples -- 16.2 Applications -- 16.3 Hedging and Valuation -- 16.3.1 Pricing and Hedging -- 16.3.2 Valuation -- 17 Single Name Book Management -- 17.1 Risk Aggregation -- 17.2 CreditVaR for CDSs -- 18 CDS and Simulation -- 18.1 The Poisson Model and Default Times -- 18.2 Valuation by Monte Carlo Simulation -- 18.3 Sensitivity -- PART III PORTFOLIO PRODUCTS -- 19 Portfolio Product Types -- 19.1 Nth-to-default Baskets -- 19.1.1 First-to-Default Product Definition and Example -- 19.1.2 Documentation and Takeovers -- 19.1.3 Second-(and Higher)-to-Default -- 19.1.4 Applications -- 19.2 'Synthetic' CDOs -- 19.2.1 Standard Indices: Markit iTraxx and Markit CDX -- 19.2.2 Index Options and Modelling Spread -- 19.2.3 CDO Structures on Standard Indices -- 19.2.4 Bespoke Synthetic CDOs -- 19.2.5 Managed Synthetic CDOs: Compliance Tests (OC and IC Tests -- WARF -- Diversity Score) and Substitutions -- 19.2.6 CDO Squared -- 19.2.7 Funded (CLN) and Unfunded (CDS) Tranches -- 19.2.8 Relationship to nth-to-Default -- 19.2.9 Applications -- 19.2.10 Portfolio Optimisation -- 19.3 Cashflow CDOs -- 19.3.1 Reference Pools -- 19.3.2 Income and Capital Waterfalls: Reserve Accounts -- 19.3.3 Funding and SPVs -- 19.3.4 Balance Sheet CDOs -- 19.3.5 Diversification and Risk Reduction Trades -- Credit Bank -- 19.4 Credit Securitisations -- 19.5 Rating -- 19.6 Alternative Levered Credit Portfolio Products -- 19.6.1 CPPI -- 19.6.2 CPDO -- 19.6.3 Advantages of Market Value CDS Products -- 20 The Normal Copula and Correlation -- 20.1 Default Time Correlation -- 20.1.1 Generating Correlated Default Times.

20.1.2 Intuitive Understanding of Default Time Correlation.