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LectureNotes07Print - IEOR E4731: Credit Derivatives...

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Unformatted text preview: IEOR E4731: Credit Derivatives Lecture 07: Risk Management of CDS Notes originally written by Prof. Rama Cont Instructor: Xuedong He Spring, 2012 1 / 10 Risk Management of Credit Derivatives I Suppose a dealer sells a CDS contract on FIAT to a customer who wants to use it to insure against the credit risk in the bonds of FIAT. The maturity and notional of this CDS contract are tailored to meet the requirement of the customer. I The dealer is in the short protection position of the CDS contract and exposed to the credit risk. He does not want to retain the risk himself. Instead, he wants to hedge this risk by trading some liquid CDS contracts in the market. I Credit risk is not the only risk in the CDS contract. For instance, the CDS contract is also subject to interest rate risk I How to hedge these risks? I General idea: sensitivity analysis 2 / 10 Hedge Options I Suppose a dealer sells a European call option and want to hedge the risk. I Consider the risk due to the change of underlying stock price I How to hedge the risk? I Suppose the dealer trade N shares of the underlying stock. Denote the value of the short position of the call by V and the value of the stock by S . Then the total value of the portfolio is = V + N S I Due to a small change of stock price, the change of portfolio...
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LectureNotes07Print - IEOR E4731: Credit Derivatives...

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