Credit Derivatives: Trading, Investing and Risk Management, Second Edition

10

CDS Deal Examples

We now look at a range of applications of the valuation formulae established above. The majority of these applications arise from trading or hedging strategies, and a thorough understanding of the analysis of these examples reveals the sources of risk in the deals and how best to control this risk.

 

 

Elementary Trading Strategies

At this point the reader should review the elementary trading strategies discussed in Chapter 8 in the light of the valuation and sensitivity results derived in Chapter 9. In particular, note that the value of a long protection position increases as the current (market) CDS premium increases - equation (9.12). Thus a bearish view (expecting CDS premiums - or bond spreads - to widen) of a particular name can be implemented by buying protection on that name. A bullish view can be reflected by selling protection or by buying bonds.

The following examples are divided into two parts: (a) purely CDS trades and (b) bond and CDS trades. A fuller analysis of CDS/bond (basis) trading is given in Chapter 11, some other CDS applications are covered in Chapter 12, and trading using credit-linked notes (CLNs) is covered in Chapter 13.

 

 

Risk Charts

We illustrate trades in this section with a ‘risk chart’ showing the spread sensitivity and the default event sensitivity. These are intended only to give a quick visual impression of the trade - they are not exact, nor do such charts in any sense replace a full risk report (which would include risks ...