Credit Derivatives Explained. Market, Products, and by O'Kane D.

By O'Kane D.

HIGHLIGHTS■ credits derivatives ate revolutionising the buying and selling of credits risk.■ The credits by-product marketplace present extraordinary notional is now with reference to SI trillion.■ credits default snaps dominate me industry and are the construction block for many credits by-product structures■ whereas banks are the foremost clients of credits derivatives, insurers and re-insurers are turning out to be in value as clients of credits derivatives.■ the focus of mis document is on explaining the mechanics, hazards and makes use of of the different sorts of credits derivative■ We set out die numerous financial institution capital remedies for credits derivatives and talk about the hot Basel Capital Accord.■ We evaluate the criminal documentation for credits derivatives.■ We talk about the impression of FAS 133 and IAS 39 on credits derivatives.

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Extra resources for Credit Derivatives Explained. Market, Products, and Regulations

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This means that the cost of the trade will depend mainly on the funding cost of the total return payer and any regulatory capital charge incurred. Pricing is determined by the cost of funding the hedge We can break out the total cost of a TRS into a number of components. First, there is the actual funding cost of the position. This depends on the credit rating of the total return payer that holds the bond on its balance sheet. If the asset can be repo’d, it depends on the corresponding repo rate.

This is useful for both buyers and sellers of protection. Fixed recovery default swaps enable investors to leverage their credit exposure and, by doing so, earn a higher yield. For example, Moody's default statistics find that senior secured debt has an average recovery rate of about 52%. An investor who sells protection on a senior bond with a fixed recovery rate of 20% is assuming a larger loss in the event of default than history would imply. The investor is leveraged and should be compensated accordingly.

Another way to make debt more liquid is to use the SPV as the issuer in the securitization of loans and trade receivables that do not exist in any traded form. In legal terms, an SPV is either a Trust or a Company. S. market and is usually organized under the law of Delaware or New York. The trustee is typically a large, highly rated bank that has a fiduciary duty to investors. Market-wide standardization of this type of product means that banks other than the arranger are familiar with the framework and are 36 Lehman Brothers International (Europe), March 2001 STRUCTURED CREDIT RESEARCH able to purchase the product.

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