Reference entities

Directory Many components need access to directory services—for example, to locate resources on a network or subcomponents within a component. They must be based on a common interface, with a uniform way to reference entities inside different components and across different naming schemes. 

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... 

Credit derivative products are defined by reference to underlying reference entities, and reference obligations, which include corporate bonds, bank loans, sovereign debt, Brady bonds, and Eurobonds. Credit derivatives are now used increasingly in structured transactions. For example synthetic collateralised loan obligations (see Chapter 15) often use credit default swaps to transfer credit risk from the originator to the special purpose vehicle (SPV). Currently, the most common products are credit default products and total return swaps. 

The market for single-name credit default swaps has rapidly developed in volume over the past few years and represents the highest proportion of the global credit derivatives market by notional value. The credit default swap is linked to the reference entity and its obligations. 

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. 

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. 

In the Conseco restructuring, this reference entity had restructured bank debt in August/September 2000 as a result of a short-term liquidity issue, therefore it changed the bank loan s maturity by a few months, how-... 

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... 

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. 

Recovery rates on bonds vary by the position in the reference entity s capital structure and the level of security offered to the bond holders. Determining the appropriate recovery rate is not a trivial process and requires careful analysis into the traded prices of deliverable obligations for the reference credit. In practice there is limited historical information on the recovery rates experienced for credit default swaps. 

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. 

Assume the reference entity also has an issued bond (which we can assume is eligible for delivery under the credit default swap contract). However, if the asset swap level of this bond is LIBOR plus 55 bps p.a. and an investor funds at LIBOR plus 5 bps p.a., the investor in the bond would pick up 50 bps p.a. holding the bond. However, this return would be less than the credit default swap premium on the same bond. The investor could generate more value from this positive basis, then asset swapping and holding the bond. 

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 ... 

The issuer of the original debt or borrower of the original loan, known as the reference entity, need not be a party to the credit risk transfer and in fact is usually not even aware of the transaction, thus allowing the client relationship between the lending bank and the borrower to be maintained. 

In capital structure arbitrage, investors exploit yield mismatches between two loans from the same reference entity. Say an issuer has two debt instruments outstanding a commercial bank loan paying 330 basis points over LIBOR and a subordinated bond issue paying LIBOR plus 230 basis points. This yield anomaly can be exploited with a total return swap in which the arbitrageur effectively purchases the bank loan and sells the bond short. 

The choice of elementary shapes starts with the straight line. Straight lines are applied as edges of flat, ruled, or other surfaces. They also serve as important reference entities such as centerlines, etc. Arcs are elements of compound lines, sections for fillets, and serve many other purposes. In addition to lines and arcs, analytical lines are the conics such as circles, ellipses, hyperbolas, and parabolas (Figure 4-1). 

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. 

If a credit event occurs on one of the reference entities in the iTraxx, the contract is physically settled, for that name, for 0.8 percent of the notional value of the contract. This is similar to the way that a single-name CDS would be settled. Unlike a single-name CDS, the contract continues to maturity at a reduced notional amount. Note that European iTraxx indices trade under Modified-Modified restructuring (MMR) terms, which is prevalent in the European market. Under MMR, a debt restructuring is named as a credit event. ... 

On the date in question, the 10-year CDS for this reference entity was quoted as 96.8 bps, which is an example of a negative basis, in this case of-22 bps. 

These references are to be bound not by the post-processor but by the receiving system at a later time, namely when the transferred information is actually used. The referred entities may have been transferred previous on a CAD I neutral file (or with some other data, format), or they may have been created in the receiving system independently. Such references are expressed by user-defined names, INDEX ENTRY properties, and REFJART LIBRARY attributes. 

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