Credit spreads Sterling market

The euro and sterling markets are broad and liquid markets. Accurately modeling spread risk in these two markets requires market-dependent, credit blocks. ... 

An average credit spread factor in the euro and sterling market. 

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. 

This same factor can also be used to compute spread risk in markets where there is not enough data to build a detailed credit block. It can also be used in markets where more detailed credit factors are available, but when there is not enough information to expose a bond to the appropriate credit factor. As we will see in what follows, this will be the case when a euro- or sterling-denominated corporate bond is not rated. Based on the observation that bonds with larger spreads are on average more risky, Barra s model assumes the following exposure to the swap factor ... 

At the time of this writing, corporate bonds denominated in currencies others than euro and sterling are only exposed to the local interest factors and if it exists, the swap factor. This swap factor is roughly equivalent to a financial AA spread factor, as the bulk of organizations that engage in swaps are AA-rated financial institutions. The swap model is coarser than the two local credit models discussed in the next section, but it performs adequately because spread changes are highly correlated within markets. 

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