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STD 246
58“65
two-asset FTD basket 240“1
uses 101
balance-sheet CDOs 136, 137
valuation considerations
bank regulatory issues 299“304
101“5
see also regulatory issues
valuing 239“48
bankruptcy, CDS 290
variations 105“6
banks
basket swap, market size 20
Basle Accord (1988) 31“5
credit risk 29“31 Basle Accord (1988) 31“5

331
332 Index

BBA survey see British Bankers cheapest to deliver (CTD),
Association survey CDS 79
bene¬ts, credit derivatives 5 CLN see credit-linked notes
Bernoulli distribution, statistics collateralization, market, credit
316 derivatives 27
Bernoulli trials, statistics 316 collateralized debt obligations
bifurcated market, CDS 295“6 (CDOs) 7
binomial distribution, statistics balance-sheet 136, 137
316“17 mechanisms 134“6
bivariate normal distribution, synthetic 133“41
statistics 323 synthetic securitization
Black-Scholes-Merton (BSM) 137“41
model traditional 133“7
credit modeling 172“8 uses 136“7
empirical validation 178“81 valuation considerations 137
extensions 178“81 valuing 258“60
practical implementation commercial modeling 261“5
178 common market practices 25“7
solving 176“8 compounding, bond math 306“7
bond math 305“11 conditional loss distribution,
compounding 306“7 portfolio credit risk
coupon-paying bonds 307“8 225“6, 237
forward bond prices 310“11 con¬rmation letter,
forward interest rates documentation issues
310“11 287
forward rates 309“10 Conseco Inc., CDS 294“5
zero-coupon bonds 305, corporate debt, synthesising long
307“9 positions 36
bond options, valuing 211 corporates, market participants
bond piece, asset swaps 59 23“5
British Bankers Association costs, transaction 5
(BBA) survey counterparty credit risk 15
credit derivatives market CDS 270“80
17“22 example 278“80
protection sellers 24“5 Hull-White approach 280
BSM see Black-Scholes-Merton modeling 267“81
model multi-name structures 281
buyer of protection 4, 24“5 simulation-based approach
277
cash ¬‚ows, PPNs 118“19 coupon-paying bonds
cash spreads, vs. CDS 76“81 bond math 307“8
CDOs see collateralized debt valuing defaultable bonds
obligations 150“2
CDS see credit default swaps credit curves 157“69
Index 333

applications, other 169 obligation acceleration 290
CDS-implied 158“64 portfolio diversi¬cation 73
¬‚at CDS curve assumption protection buyers 70“1
162“3 protection sellers 71“2
implied survival reference entities 288“9
probabilities 159“64 repudiation/moratorium
marking to market a CDS 290
position 164“6 restructuring 290
PPNs 166“9 restructuring debate 293“6
PPNs vs. vanilla notes risks 72“3
168“9 safeguards 291“3
rule of thumb 163“4 settlement method 289
credit default swaps (CDS) 4, single-name instruments
67“82 6“7, 138
bankruptcy 290 static replication 76“8
basic model 268“70 terms 288“90
bifurcated market 295“6 transaction anatomy 285“97
vs. cash spreads 76“81 two-asset portfolio 268
caution 291 unfunded instruments 35“6
Conseco Inc. 294“5 uses 70“3
contract settling 292“3 valuation considerations
counterparty credit risk 73“81, 181“3, 197“8
272“80 valuing restructuring clause
credit curves 158“64 296“7
credit events 289“90 variations 82
CTD 79 veri¬cation 291“2
default events 69 credit default swaptions, valuing
deliverable obligations 289 208“10
documentation issues credit derivatives market see
285“97 market, credit
examples 68“9, 72“3 derivatives
failure to pay 290 credit events, CDS 289“90
forward-starting contracts credit-linked notes (CLN) 8,
205“8 123“6
implied survival market size 20
probabilities 296“7 mechanisms 123“5
ISDA 69 uses 125
market size 20 valuation considerations 125
mechanisms 68“70 variations 125
modi¬ed restructuring credit modeling 171“204
295“7 Black-Scholes-Merton
no counterparty credit risk (BSM) model 172“8
270“2 CDS valuation 181“3
noti¬cation 291“2 JLT model 200“4
334 Index

credit modeling (continued ) credit support
documentation 287“8
ratings-based models 200“4
ISDA 286“9
reduced-form approach
ISDA credit derivatives
183“98
de¬nitions 287
structural approach 172“83
market, credit derivatives 26
credit options, valuing 205“11
master agreement 286“7
credit protection
supplements 287
buyers 4, 24“5
sellers 4, 24“5
embedded interest rate swap,
credit quality, reference entities
asset swaps 59“62
21“3
end-users, credit derivatives 23“5
credit ratings, reference entities
expected value and variance,
22
statistics 315“16
credit risk, asset swaps 57“8
exponential distribution,
credit risk management, banks
statistics 317“20
29“31
credit support documentation,
failure to pay, CDS 290
documentation issues
¬rst-to-default basket swap 7
287“8
¬rst-to-default (FTD) basket
CreditMetrics, modeling 262
contract 99“106
CreditRisk, modeling 263“4
asset correlation 247“8
CTD see cheapest to deliver
reference entities 241“6
cumulative distribution function,
two-asset 240“1
statistics 313
FitchRatings survey (2003),
credit derivatives
default correlation market 17“18, 21“2
loss distribution function ¬‚oating-rate notes (FRNs) 43“51
113“15, 230“1 cf. asset swaps 62“5
modeling 219“22 interest rates 46“51
pairwise 223“4 LIBOR 43“5
portfolio credit risk 215“24, reset risk 46“51
230“1 uses 45
default events, CDS 69 valuation considerations
default intensity, credit 45“51
modeling 188“90 forward bond prices, bond math
defaultable bonds see valuing 310“11
defaultable bonds forward default probabilities,
deliverable obligations, CDS 289 credit modeling 185“6
demand/supply/market frictions forward default rates, credit
14“15 modeling 186“8
documentation issues forward interest rates, bond
CDS 285“97 math 310“11
con¬rmation letter 287 forward rates, bond math 309“10
Index 335

forward-starting contracts, large-portfolio approximation
valuing credit options loss distribution function
205“8 228“30, 235“7
PDS 257“8
FRNs see ¬‚oating-rate notes
legal risk 11“12
FTD see ¬rst-to-default basket
leveraging credit exposure 35“6
contract
LIBOR see London Interbank
further reading 303“4
O¬ered Rate
liquidity, credit market 5
gains from trade 5
loan origination alternative,
protection sellers 39
hedge funds lognormal distribution, statistics
asset swaps 57 321“2
market participants 23“5 London Interbank O¬ered Rate
hedging (LIBOR)
convertible bond investors FRNs 43“5
38“9 LIBOR curve 93“4
vendor-¬nanced deals 38 long positions, corporate debt 36
Hull-White approach, loss distribution function
counterparty credit risk conditional 225“6, 237
280 default correlation 113“15,
230“1
large-portfolio
implied survival probabilities
approximation 228“30,
CDS 296“7
235“7
credit curves 159“64
PDS 111“15
independence, statistics 323
portfolio credit risk 224“31
insurers, market participants
unconditional 226“8, 237
23“5
interest rates, FRNs 46“51
market, credit derivatives 17“27
International Swaps and
activity 19“23
Derivatives Association
BBA survey 17“22, 24“5
(ISDA)
collateralization 27
CDS 69
common market practices
documentation issues 286“9
25“7
documentation issues 26
Jarrow-Lando-Turnbull (JLT) evolution 18“19
model, credit modeling FitchRatings survey (2003)
200“4 17“18, 21“2
joint probability distributions, global 18
statistics 322 instrument type, activity by
19“23
KMV Framework, modeling netting 27
262“3 participants 23“5
336 Index

market, credit derivatives nonzero recovery, valuing default-
(continued ) able bonds 152“3, 192“3
normal distribution, statistics
Risk Magazine surveys
320“1
17“22
size 18“19
obligation acceleration, CDS 290
size, activity by 19“23
overview, credit derivatives 3“15
US 19
market frictions/supply/demand
pairwise default correlation
14“15
223“4
market indicators, credit
par ¬‚oaters, cf. asset swaps 62“5
derivatives as 39“40
PDS see portfolio default swaps
master agreement,
Poisson distribution, statistics
documentation issues
317“20
286“7
portfolio credit risk 215“38
maturities, commonly negotiated
alternative approaches 238
contracts 23
conditional loss distribution
model-based valuation, PDS
225“6, 237
252“5
default correlation 215“24,
model risk 12
230“1
modeling
extensions 238
commercial 261“5
loss distribution function
counterparty credit risk
224“31
267“81
Monte Carlo Simulation
CreditMetrics 262
231“7
CreditRisk 263“4
unconditional loss
KMV Framework 262“3
distribution 226“8, 237
Moody™s binomial
portfolio default swaps (PDS) 7,
expansion technique
107“16
264“5
asset correlation 255“6
vs. static replication 12“14
example, valuation 249“51
modeling, credit see credit
large-portfolio
modeling
approximation 257“8
Monte Carlo Simulation,
loss distribution function
portfolio credit risk
111“15
231“7
market size 20
Moody™s binomial expansion
mechanisms 107“10
technique, modeling
model-based valuation
264“5
252“5
multi-name instruments 7
uses 110
market activity 20“1
valuation considerations
110“15
netting, market, credit valuing 249“60
derivatives 27 variations 116
Index 337

portfolio diversi¬cation 35“6 credit quality 21“3
CDS 73 credit ratings 22
potential bene¬ts, credit FTD 241“6
derivatives 5 market size 21“3
PPNs see principal-protected risks 10“11
notes sovereign reference entities
principal-protected notes 8“9
(PPNs) 117“22 regulatory issues 299“304
cash ¬‚ows 118“19 Basel II Capital Accord
credit curves 166“9 300“2
mechanisms 117“19 Basel II Risk Weights and
uses 119 Credit Derivatives
valuation considerations 302“3
119“22 regulatory barriers 5
valuing 166“9 regulatory capital
vs. vanilla notes 168“9 management, banks
variations 122 31“5
zero-coupon bonds 120“2 reinsurers, market participants
principal-protected structures 23“5
117“22 repackaging vehicles see
probability density function, special-purpose vehicles
statistics 314“15 repudiation/moratorium, CDS
probability function, statistics 290
314 reset risk, FRNs 46“51
protection buyers 4, 24“5 restructuring, CDS 290
CDS 70“1 restructuring debate, CDS 293“6
protection sellers 4, 24“5 Risk Magazine, surveys, market
CDS 71“2 17“22
loan origination alternative risk-neutral
39 valuation/probability,
risks 10“11 valuing defaultable
bonds 147“50
ratings-based models, credit risks 3“4
modeling 200“4 CDS 72“3
rationale, credit derivatives 3“4 counterparty credit risk 15
recovery rates, valuing credit risk 29“31, 57“8
defaultable bonds credit risk management,
154“6 banks 29“31
reduced-form approach legal 11“12
credit modeling 183“98 model 12
cf. structural approach protection sellers 10“11
198“200 reference entities 10“11
reference entities 4, 8“9 reset risk 46“51
CDS 288“9 types 10“12
338 Index

risky bond spreads, valuing expected value and variance
defaultable bonds 315“16
153“4 exponential distribution
317“20
second-to-default (STD) basket independence 323
246 joint probability
settlement method, CDS 289 distributions 322
shorting corporate bonds 37“8 lognormal distribution
single-name CDS, two-asset 321“2
portfolio 268 normal distribution 320“1
single-name instruments 6“7 Poisson distribution 317“20
market activity 20“1 probability density function
sovereign reference entities 8“9 314“15
market size 21 probability function 314
special-purpose vehicles (SPVs) STD see second-to-default
127“30 basket
market participants 23“5 stochastic interest rates, credit
mechanisms 127“30 modeling 184“5
reasons 129“30 structural approach
synthetic securitization credit modeling 172“83
137“41 cf. reduced-form approach
valuation considerations 130 198“200
variations 130“1 supplements, documentation
spread and bond options 91“7 issues 287
mechanisms 91“3 supply/demand/market frictions
uses 93“5 14“15
valuation considerations surveys, market
95“6 BBA survey 17“22, 24“5
variations 96“7 FitchRatings survey (2003)
spread option, market size 20 17“18, 21“2
SPVs see special-purpose Risk Magazine 17“22
vehicles synthesising long positions,
static replication corporate debt 36
CDS 76“8 synthetic CDOs 133“41
vs. modeling 12“14 uses 139“40
statistics 313“23 valuation considerations 140
Bernoulli distribution 316 variations 140“1
Bernoulli trials 316 synthetic securitization, SPVs
binomial distribution 137“41
316“17
bivariate normal third-party asset managers,
distribution 323 market participants
cumulative distribution 23“5
function 313 total return swaps (TRS) 83“90
Index 339

market size 20 PPNs 119“22
mechanisms 83“5 spread and bond options
uses 85“7 95“6
valuation considerations SPVs 130
87“9 synthetic CDOs 140
variations 89“90 TRS 87“9
transaction costs 5 valuation principles 9“15
TRS see total return swaps valuing basket default swaps see
two-asset FTD basket 240“1 basket default swaps
two-asset portfolio, single-name valuing bond options 211
CDS 268 valuing collateralized debt
types, credit derivatives 6“9 obligations 258“60
valuing credit default swaptions
uncertain time of default, credit 208“10
modeling 190“1 valuing credit options 205“11
unconditional loss distribution forward-starting contracts
function 226“8, 237 205“8
unfunded instruments, CDS valuing defaultable bonds
35“6 145“56, 191“6
uses, credit derivatives 29“40 alternative recovery
credit risk management, assumptions 193“6
banks 29“31 coupon-paying bonds 150“2
hedging by convertible bond nonzero recovery 152“3,
investors 38“9 192“3
hedging vendor-¬nanced recovery rates 154“6
deals 38 risk-neutral
market indicators 39“40 valuation/probability
portfolio diversi¬cation 35“6 147“50
regulatory capital risky bond spreads 153“4
management, banks zero-coupon bonds 145“50
31“5 valuing portfolio default swaps
shorting corporate bonds 249“60
37“8 valuing principal-protected notes
yield enhancement 35“6 166“9

valuation considerations yield enhancement 35“6
asset swaps 58“65
basket default swaps 101“5 zero-coupon bonds
CDOs 137 bond math 305, 307“9
CDS 73“81, 181“3, 197“8 payout scenarios 147“9
CLN 125 PPNs 120“2
FRNs 45“51 valuing defaultable bonds
PDS 110“15 145“50, 191“6

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