Credit events

The price of a corporate bond is a yield spread for conventional bonds or on an OAS basis for callable or other option-embedded bonds. If an OAS calculation is undertaken in a consistent framework, price changes that result in credit events will result in changes in the OAS. Therefore, we can speak in terms of a sensitivity measure for the change in value of a bond or portfolio in terms of changes to a... 

Covered bondholders, in the event of issner insolvency and provided that the covering assets continue to meet regulator requirements, will still receive interest and principal payments according to the contractual dates (with the exception of Spain). However, certain credit events such as deterioration in the quality of the underlying assets for example, would trigger the acceleration of ABS/MBS payments. 

The payout to the protection buyer is zero if there is no credit event, or in the event of a credit event such as bankruptcy, par value less the recovery rate. 

Credit default swaps are triggered by the occurrence of credit events. If a counterparty provides a Credit Event Notice than this indicates that a credit event has occurred, this is usually accompanied by Public Available Information. 

Upon a credit event the settlement of CDSs may be performed in two ways ... 

Experience during 2001 and 2002 has shown an increase in credit events which trigger payments on credit derivatives. Examples of high-profile credit events included Swiss Air (Bankruptcy), Railtrack (Bankruptcy), and Enron (Bankruptcy). 

The legal department of most firms that buy or sell credit derivative instruments carefully monitor the terms of the transaction and in particular will focus on any nonstandard terms. In most cases the market will trade on standard ISDA documentation (terms and definitions). Sources of dispute, which are rare, may arise on the actual contract terms the nature of credit events, the obligation selected by the protection buyer for delivery. 

An interesting development in the credit default swap market is the response of protection sellers to credit events, the impact is ultimately reflected in the price of credit default swaps, as reflected by the credit default swap spread. Credit derivative markets have experienced spread widening at times of bad credit related news, in effect this reflects the protection sellers pricing the risk of the additional probability of a credit event into the protection they sell. 

Credit default counterparties require absolute clarity on the terms of the CDS at the time they enter into transactions for example, the reference entity, reference obligation characteristics and deliverable obligation characteristics, credit events, and valuation process are key discussion points. 

Another adaptation of the credit default swap is the digital CDS in which a defined cash flow on the contingent leg takes place when a credit event occurs. 

In the event of default the protection buyer would be compensated for any loss in value as a result of a credit event affecting the market value of the reference asset. 

In some versions of a TRS the actual underlying asset is actually sold to the counterparty, with a corresponding swap transaction agreed alongside in this type of TRS, the protection seller will make an upfront payment for the market value of the reference asset to the protection buyer. Yet another variation involves no change in physical ownership but still involves an upfront payment of the market value of the reference asset an example of this kind of TRS is described in Exhibit 21.4. On occurrence of a credit event the TRS will be terminated using physical settlement, so that the reference asset is delivered to the protection seller. 

TRS are connected to changes in the market value of the underlying asset, as well as changes resulting from the occurrence of a credit event. 

A variety of credit-linked structures may be created to suit the various risk/reward profiles of investors. For example, some CLNs may protect the principal amount and credit events may only affect the interest cash flow from the CLN whereas others may link the redemption of principal to the performance of reference credit instruments. 

The 1999 ISDA Credit Derivatives Definitions listed six credit events that could be incorporated into credit default swaps. These are... 

Credit events for corporate entities nsually conform to ISDA credit derivative definitions and snpplements. The events currently commonly used in most CDS confirmations are ... 

There have been interesting developments concerning the Restructuring credit event. The restructuring credit event has been considered in the light of market experience involving the actual credit events, for example the Conseco case. 

The Supplement Relating to Successor and Credit Events to the 1999 ISDA Credit Derivatives Definitions was introduced on 28 November 2001 to clarify the treatment of reference entities which may be affected by a succession event (for example mergers, demergers, or corporate reorganisations). The successor is determined by considering... 

For credit derivative contracts in which the payout is on credit events other than default, the modeling of the credit evolutionary path is critical. If, however, a credit derivative contract does not payout on intermediate stages between the current state and default then the important factor is the probability of default from the current state. 

Perhaps the most important part of the default swap is the payment the buyer of protection will receive if a default occurs during the life of the swap. After all, this is precisely the protection the buyer is paying for. Upon a default, the buyer of protection will receive the notional amount of the swap after delivering to the seller-defaulted assets of the issuer. We define recovery value, or more briefly R, to be the value of these defaulted assets immediately following the credit event, so it can be more easily stated that upon a default the buyer of protection will receive 100% - R. 

Gup and Brooks (1993) noted that swaps credit risk, unlike their interest rate risk, could not be hedged. That was true in 1993. The situation changed quickly, however, in years following. By 1996 a liquid market existed in instruments designed for just such hedging. Credit derivatives are, in essence, insurance policies against a deterioration in the credit quality of borrowers. The simplest ones even require regular premiums, paid by the protection buyer to the protection seller, and make payouts should a specified credit event occur. 

Credit derivatives are financial contracts designed to reduce or eliminate credit risk exposure by providing insurance against losses suffered because of credit events. The loan or bond carrying the credit risk in question is the ref-... 

The most common credit derivative, and possibly the simplest, is the credit default swap—also known as the credit or default swap. As diagrammed in FIGURE 10.4, it is a bilateral contract in which a protection seller, or guarantor, in return for a periodic fixed fee or a onetime premium agrees to pay the beneficiary counterparty in case any of a list of specified credit events occurs. The fee is usually quoted as a percentage of the nominal value of the reference asset or basket of assets. The swap term does not have to... 

In exotic credit options, one or more parameters differ from the vanilla norm. A barrier credit option, for example, specifies a credit event... 

Credit-linked notes are hybrid securities, generally issued by an investment-grade entity, that combine a credit derivative with a vanilla bond. Like a vanilla bond, a standard CLN has a fixed maturity structure and pays regular coupons. Unlike bonds, all CLNs, standard or not, link then-returns to an underlying asset s credit-related performance, as well as to the performance of the issuing entity. The issuer, for instance, is usually permitted to decrease the principal amount if a credit event occurs. Say a credit card issuer wants to fond its credit card loan portfolio by issuing debt. To reduce its credit risk, it floats a 2-year credit-linked note. The note has a face value of 100 and pays a coupon of 7.50 percent, which is 200 basis points above the 2-year benchmark. If more than 10 percent of its cardholders are delinquent in making payments, however, the note s redemption payment will be reduced to 85 for every 100 of face value. The credit card issuer has in effect purchased a credit option that lowers its liability should it suffer a specified credit event—in this case, an above-expected incidence of bad debts. 

If a credit event occurs, the SPV usually pays out a cash amount equal to the par value of the underlying assets covered by the credit default swap, less their post-default price. Less commonly, the SPV physically settles the credit-default swap by purchasing the defaulted assets at par value. The credit loss is then passed on to the investors according to the priority of the tranches they hold. 

Various methods are available to limit the damage from the effects of explosions. The best options are to provide some pre-installed or engineered features into the design of the facility or equipment that allows for the dissipation or diversion of the effects of a blast to non-consequential areas. Wherever these mechanisms are used the overpressure levels utilized should be consistent with the risk analysis estimates of the worst case creditable event (WCCE) incident. 

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