Ch21HullFundamentals6thEd - Credit Derivatives Chapter 21...

Info iconThis preview shows pages 1–7. Sign up to view the full content.

View Full Document Right Arrow Icon
Fundamentals of Futures and Options Markets , 6 th Edition, Copyright © John C. Hull 2007 21.1 Credit Derivatives Chapter 21
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Fundamentals of Futures and Options Markets , 6 th Edition, Copyright © John C. Hull 2007 21.2 Credit Derivatives Derivatives where the payoff depends on the credit quality of a company or sovereign entity The market started to grow fast in the late 1990s By 2006 notional principal totaled over $20 trillion
Background image of page 2
Fundamentals of Futures and Options Markets , 6 th Edition, Copyright © John C. Hull 2007 21.3 Credit Default Swaps (page 461) Buyer of the instrument acquires protection from the seller against a default by a particular company or country (the reference entity) Example: Buyer pays a premium of 90 bps per year for $100 million of 5-year protection against company X Premium is known as the credit default spread . It is paid for life of contract or until default If there is a default, the buyer has the right to sell bonds with a face value of $100 million issued by company X for $100 million (Several bonds may be deliverable)
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Fundamentals of Futures and Options Markets , 6 th Edition, Copyright © John C. Hull 2007 21.4 CDS Structure Default Protection Buyer, A Default Protection Seller, B 90 bps per year Payoff if there is a default by reference entity=100(1- R ) Recovery rate, R , is the ratio of the value of the bond issued by reference entity immediately after default to the face value of the bond
Background image of page 4
Fundamentals of Futures and Options Markets , 6 th Edition, Copyright © John C. Hull 2007 21.5 Other Details Payments are usually made quarterly or semiannually in arrears In the event of default there is a final accrual payment by the buyer Settlement can be specified as delivery of the bonds or a cash equivalent amount Suppose payments are made quarterly in the example just considered. What are the cash flows if there is a default after 3 years and 1 month and recovery rate is 40%?
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Fundamentals of Futures and Options Markets , 6 th Edition, Copyright © John C. Hull 2007 21.6 Attractions of the CDS Market Allows credit risks to be traded in the
Background image of page 6
Image of page 7
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 24

Ch21HullFundamentals6thEd - Credit Derivatives Chapter 21...

This preview shows document pages 1 - 7. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online