Credit spreads reference

The terms spread or credit spread refer to the yield differential, usually expressed in basis points, between a corporate bond and an equivalent maturity government security or point on the government curve. It can also be expressed as a spread over the swap curve. In the former case, we refer to the fixed-rate spread. In the latter, we use the term spread over EURIBOR, or over the swap curve. 

Moreover, duration will be influenced by the floater s stmcture. In fact, the choice of the reference rate affects the duration depending on how much volatile the index is. The lower the frequency of couptm payments, the greater the price sensitivity between reset dates. Thus, while floating-rate notes have a lower price sensitivity to a change of the reference rate, fixed and floating-rate notes both have a price sensitivity to changes of credit spread reflecting the issuer s creditworthiness. A shift of the credit term structure will determine the decline of the bond s price. 

Since credit default swaps are written on the reference entities, their pricing provide information on the default probabilities of the issuer and are not subject to liquidity premia that can be present in the credit spreads of the credit risky bonds. Therefore, the term structure of credit default swap spreads for a particular issuer is used to determine the cumulative default probability of the issuer. 

Forward credit spreads are based on the risky forward rate less the riskfree forward rate. The forward credit spread can be estimated as the difference between the forward yield for a benchmark bond and the yield on the reference credit asset. 

Credit spread options are options whose payout is linked to the credit spread of the reference credit. This product can be used to manage the credit risk on corporate bond and corporate bond option positions. It isolates credit spread risk, which is an important factor in the underling... 

Various credit derivatives may be priced using this model for example, credit default swaps, total return swaps, and credit spread options. The pricing of these products requires the generation of the appropriate credit dependent cash flows at each node on a lattice of possible outcomes. The fair value may be determined by discounting the probability-weighted cash flows. The probability of the outcomes would be determined by reference to the risk neutral transition matrix. 

Credit spread products are a rapidly growing class of credit derivative. The spread in the following sections relate to a credit spread over a benchmark security. However, the traded credit spread could also refer to the CDS spread. 

A key issue with credit spread options is ensuring that the pricing models used will calibrate to the market prices of credit risky reference assets. The recovery of forward prices of the reference asset would be a constraint to the evolution of the credit spread. More complex spread models may allow for the correlation between the level of the credit... 

Credit options allow market participants to express their views on credit alone, without reference to other factors, such as interest rates, with no cost beyond the premium. For example, investors who believe that the credit spread associated with an individual entity or a sector (such as all AA-rated sterling corporates) will widen over the next six months can buy six-month call options on the relevant spread. If the spread widens beyond the strike during the six months, the options will be in the money, and the investors will gain. If not, the investors loss will be limited to the premium paid. 

Note that CSOl refers to the credit risk exposure of a CDS position, meaning the change in value of the CDS contract for a 1 basis point change in credit spread. 

Table 10.5 illustrates the pricing of a CDS contract written on the reference entity whose credit spread premium over the risk-free rate was introduced earlier. The default probabilities were calculated as shown in Table 10.4. 

Positions that had been held on the trading book of some banks became difficult to value and risk manage due to the withdrawal of liquidity. Some risk measurement systems did not make sufficient allowance for the risk of significant credit spread widening and credit migration, since they referred to risk data sets for the previous two to three years before 2007, which showed a fairly stable credit environment. 

The Bloomberg ASW screen shows the Z-spread. It is 46.1 for HERIM and 45.9 for TKAAV. The Z-spread provides hence a better measure of spread, although giving a similar result in terms of investor s decision. However, being a constant measure, it does not consider the timing of default In fact, each cash flow has a different level of credit risk. To overcome this hmitatirHi, the Z-spread spread could be adjusted by introducing a probability of default for each cash flow. This other spread is referred to adjusted Z-spread or C-spread. 

A credit default swap (CDS) price provides fundamental credit risk information of a specific reference entity or asset. As explained before, asset swaps are used to transform the cash flows of a corporate bond for interest rate hedging purpose. Since the asset swaps are priced at a spread over the interbank rate, the ASW spread is the credit risk of the same one. However, market evidence shows that credit default swaps trade at a different level to asset swaps due to technical... 

Issues are initially priced and sold at a fixed spread over the reference rate. The price of an FRN can fluctuate considerably during the life of the issue, mainly depending on trends in the issuer s credit quality. The frequent resets in the reference rate means that changes in market interest levels have a minimal impact on an FRN s price. For investors, movements in an FRN s price are reflected in changes in the discount rate. The discount rate is effectively the yield needed to discount the future cash flows on the security to its current price. It thus functions in the same way as the yield to maturity for a fixed-rate instrument. And like a fixed-rate bond, the market convention is to use a constant spread... 

Asset swaps are used to alter the cash flow profile of a bond. The asset swap market is an important segment of the credit derivatives market since it explicitly sets out the price of credit as a spread over LIBOR. Pricing a bond by reference to LIBOR is commonly used and the spread over LIBOR is a measure of credit risk in the cash flow of the underlying... 

The pricing of credit default swaps is determined in the credit default swap market by traders who determine the credit default swap spread through their assessment of the default risk of the reference obligations. This spread information can give valuable information about the key pricing components of the reference credit implied probability of default of the reference credit and recovery assumptions. These price... 

In practice, the spread information from the CDS market is used to imply the probability of default and the hazard rate for the underlying reference entity. The recovery rate is an input when the calculation of implied probabilities takes place. It is common to assume a recovery rate that reflects the rate on the cheapest to deliver deliverable obligation. Credit derivative traders will monitor the prices of the cheapest to deliver bonds (i.e., deliverable obligations with the lowest recovery), when constructing hedges. 

The credit curves (or default swap curves) reflect the term structure of spreads by maturity (or tenor) in the credit default swap markets. The shape of the credit curves are influenced by the demand and supply for credit protection in the credit default swaps market and reflect the credit quality of the reference entities (both specific and systematic risk). The changing levels of credit curves provide traders and arbitragers with the opportunity to measure relative value and establish credit positions. 

However, it is also possible that an investor may find that there is a negative basis. For example, the credit default swap spread is less than the asset swap level for a cash instrument issued by the same reference entity. This situation may arise in the markets ... 

After assessing a bond with the help of credit analysis, the question arises to what extent the market price of this bond corresponds with the investor s judgement. The market price should compensate the investor for all risks connected with holding the bond. This market price (spread) is often referred to as the return differential between the analysed bond and the benchmark. Frequently, government bonds or the swap rate with matching maturities are used as benchmarks. Another standard reference are bonds of other issuers that are active in the same business field. Since one debt instrument is assessed relative to another debt instrument, this analysis is also called relative value analysis, the basic principles of which are described in this section. 

The spread of the periodic table in Spanish textbooks appears to have been associated with the first successful predictions of new elements (gallium and scandium) and the publication of Mendeleev s papers in French journals (Comptes Rendus de I Academie des Sciences and Moniteur Scientifique), in which he took credit for the successful prediction of the new elements. The discovery of gallium was mentioned in Spanish newspapers during the fall of 1875, just a few months after Lecoq de Boisbaudran s announcement at the Academy of Science in Paris. After 1880 most of the Spanish textbooks that included references to Mendeleev s classification also mentioned the predictions and the related discoveries as proof of the scientific value... 

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