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Credit Derivatives: A Primer on Credit Risk, Modeling, and Instruments

Book Description

Every company faces credit risk. Credit derivatives are among the most powerful tools available for managing it. Once restricted to the financial industry, they are now widely used by businesses of all kinds—and all financial professionals need to understand them. Credit Derivatives, Revised Edition, explains these tools simply, clearly, and rigorously: what they do, how they work, and how to use them in today’s applications.

The authors first show how credit risk can be measured and valued. They explain key ideas, such as recovery rates and credit spreads, and show how derivatives transfer credit risk to external investors. Next, they systematically demonstrate how credit risk models can describe and predict credit risk events. They cover structural models, including Merton and Black and Cox; empirical models, such as the Z-score model; and reduced-form models, such as Jarrow-Turnbull. The authors also present detailed explanations of two widely used instruments: credit default swaps (CDSs) and collateralized debt obligations (CDOs).

Finally, building on what you’ve learned, the authors offer a brand-new primer on today’s applications for financial instruments with embedded credit risk.

Perform preliminary financial analysis on any potential project

Master core concepts, from credit spreads to default probabilities

Learn structural, empirical, and reduced-form credit risk modeling

Understand CDSs, CDOs, and how credit-sensitive products are now used

For CFOs, treasurers, and other practitioners—everywhere from pension funds to commercial corporations

Table of Contents

  1. Title Page
  2. Copyright Page
  3. Contents
  4. About the Authors
  5. Acknowledgments
  6. Part I. What is Credit Risk
    1. 1. Introduction
      1. A Disease Known as Credit Risk
      2. Curing Credit Risk: Credit Derivatives
      3. Who Suffers from Credit Risk?
      4. How to Read This Book
      5. Endnotes
    2. 2. About Credit Risk
      1. The Building Blocks of Credit Risk
      2. Credit Risk Definition
      3. Measuring Credit Risk Through Credit Spread
      4. Evaluating Default Probability: Credit Rating Agencies
      5. Credit Risk Statistics
      6. Credit Derivatives
      7. Credit Derivatives Market
      8. Endnotes
  7. Part II. Credit Risk Modeling
    1. 3. Modeling Credit Risk: Structural Approach
    2. What Do Credit Risk Models Do?
      1. Structural Credit Risk Models
      2. Review of Options
      3. The Merton Model
      4. Extending the Merton Model
      5. Appendix to Chapter 3. The Longstaff and Schwartz Model
      6. An Example of Applying Longstaff and Schwartz
      7. Endnotes
    3. 4. Modeling Credit Risk: Alternative Approaches
      1. Empirical Models of Default, or Credit Scoring Models
      2. Reduced Form Modeling
      3. Appendix to Chapter 4
      4. Finding Default Intensity
      5. Example Using Jarrow-Turnbull
      6. Sensitivity Analysis of Jarrow-Turnbull Model
      7. Endnotes
  8. Part III. Typical Credit Derivatives
    1. 5. Credit Default Swaps
      1. What Are Swaps?
      2. Credit Default Swaps Defined
      3. Pricing CDSs
      4. The CDS Market
      5. Endnotes
      6. 6. Collateralized Debt Obligations
    2. The Mechanics of CDOs
      1. CDO Credit Enhancement
      2. The CDO Market
      3. Appendix to Chapter 6. Pricing a CDO
      4. Pricing a CDO: The Theory
      5. An Alternative CDO Pricing Method: The Copula Function
      6. Endnotes
    3. 7. Applications of Credit Derivatives and Financial Engineering
      1. Power Plant Conversion
      2. Capital Efficiency
      3. Synthetic Credit Risk
      4. Securitized Risk Conveyance
      5. Endnotes
  9. Index