|
|
 |
The Credit Default Swap Basis
Moorad Choudhry
Format: Hardcover
ISBN: 1576602362
Publisher: Bloomberg Press
Pub. Date: 10/2006
194 pages, 5-1/2" x 8-1/4"
Retail Price: $50.00
Your Price: $42.50
|
|
|
 |
|
|
|
|
|
|
Dr. Moorad Choudhry is head of Treasury at KBC Financial Products in London. He is a visiting professor at the Department of Economics, London Metropolitan University, a visiting research fellow at the ICMA Centre, University of Reading; a senior fellow at the Centre for Mathematical Trading and Finance, Cass Business School; and a fellow of the Securities and Investment Institute. Choudhry is the author of numerous books, including Fixed-Income Securities and Derivatives Handbook.
Top of Page  |
|
|
|
|
|
|
|
"A timely and well-researched book on a key aspect of the credit derivatives market. Investors will gain much valuable insight from Moorad Choudhry’s landmark text on the credit default swap basis, its drivers, and its behavior."
--Suleman Baig
Deutsche Bank Global Markets
"As credit default swaps become ever more important as a bank risk-management tool, so market participants will need to understand the credit market cash-synthetic basis. This is an excellent treatment of the subject that provides valuable detail for investors and traders alike."
--Mohamoud Barre Dualeh
Abu Dhabi Commercial Bank
"An excellent account and one sure to be of inestimable value to market practitioners."
--Mark Burgess
Synthetic ABCP Operations, KBC Financial Products
Top of Page |
|
|
|
|
|
|
|
Foreword by Richard Pereira, Vice President, JP Morgan Securities Ltd.
1 A Primer on Credit Default Swaps
2 Bond Spreads and Relative Value
3 The CDS Basis I: The Relationship Between Cash and Synthetic Credit Markets
4 Supply and Demand and the Credit Default Swap Basis
5 The CDS Basis II: Further Analysis of the Cash and Synthetic Credit Market Differential
6 Trading the CDS Basis: Illustrating Positive and Negative Basis Arbitrage Trades
Appendix I Description of Bloomberg Screen CDSW
Appendix II The Market Approach to CDS Pricing
Appendix III Market-Implied Timing of Default from
CDS Prices Glossary
Index
CFA Institute Professional Development Qualified Activity (7 hours)
Top of Page |
|
|
|
|
|
|
|
This is a book about the credit default swap basis. It is not a book about credit default swaps, much less a book about credit derivatives, a subject that is the focus of a great many books these days. Of course it closely concerns credit default swaps—or rather, one particular aspect of their trading, analysis, and performance—and so readers should be familiar with the credit default swap (henceforth CDS) as a financial instrument. But it is not a book about the CDS per se. It is about an aspect of CDS behavior that is, whether appreciated by them or not, of importance to all users of CDS products. This is the basis, which can be loosely defined as the relationship between the cash and synthetic credit markets.
A basis exists in all markets where cash and derivative forms of the same asset trade side by side. For example, there is a crude oil basis, and a government bond futures basis. Put simply, the basis is the difference in price between the cash form of an asset and the price of that asset when represented by a derivative contract written on that asset. Depending on the type of asset we are talking about, whether financial or physical, the basis will have a value that it should be. However, various factors combine to make the basis move away from its theoretical value, and it is this divergence that is of importance to market participants. Why is the credit default swap basis important? Because it is the measure by which investors—indeed, all market participants—can assess relative value in the credit markets, for both cash bonds and CDSs. The relationship and interplay between the two markets is captured in the basis. Thus, the basis becomes the key measure of relative value for credit-risky assets, as well as an indicator of mispricing of these assets, whether they are in cash or synthetic form.
The use of interest-rate derivatives increased liquidity in the world’s financial markets. Such instruments made it easier for users and providers of capital to price and hedge cash market debt capital products. Interest-rate swaps are now a leading indicator in the financial markets and a tool by which cash market efficiency is maintained. We can observe a similar development occurring in credit markets. Credit derivatives were introduced around 1994, although a liquid market did not develop until a few years after that. They are now an important part of the global capital markets, and have contributed to increased liquidity in the cash credit market. They also enable market participants to price credit as an explicit asset class.
As the synthetic market in credit becomes a reliable indicator of the cash market in credit, mirroring the development in interest-
rate markets a generation before, it is important for all market participants to become familiar with the two-way relationship between the two markets. The relationship is represented by the credit default swap basis: a measure of the difference in price and value between the cash and synthetic credit markets.
The growth of the credit derivatives market has produced a highly liquid market in credit default swaps across the credit curve. This liquidity in turn has helped to generate further growth in the market. There is a wide range of users of credit default swaps, from banks and other financial institutions to corporate and supranational bodies. The liquid nature of the credit default swap market has resulted in many investors accessing synthetic, rather than cash, markets in corporate credit. As well as greater
liquidity, the synthetic market also offers investors the opportunity to access any part of the credit term structure, and not just those parts of the term structure where corporate borrowers have issued bonds. The liquidity of the synthetic market has resulted in many investors accessing both the credit derivatives and the cash bond markets to meet their investment requirements.
This book considers the close relationship between the synthetic and cash markets in credit. We look first at why in theory the price of the cash and synthetic products should be identical. We then look at why the synthetic market price will necessarily differ from the cash market price. We consider the factors that drive this non–zero basis, and the implications this has for market participants. We consider the latest developments and the most effective approach to calculate the basis. We discuss the concept of the basis trade, the quintessential arbitrage trade, and the mechanics behind it. Because the basis is a quantitative measure of relative value between cash and synthetic credit markets, any calculation methodology needs to compare like-for-like yield spreads. We assess the different methodologies that may be employed, and conclude that the adjusted basis—which is the difference between the adjusted CDS spread, or C-spread, and the cash bond Z-spread—is the most effective measure of the basis. The adjusted CDS spread uses the synthetic market credit term structure to adjust cash bond market yields. Finally, we illustrate key concepts with real-world examples of positive and negative basis arbitrage trades. But to begin with, we present some essential background on the CDS itself, the concept of bond spreads and relative value, and plain vanilla CDS pricing.
An understanding of the basis is, we feel, of vital importance to anyone with an involvement in the credit-risky debt capital markets, whether as investor, trader, or broker. As such, this book is aimed at, among others, those working in financial institutions and related firms. We hope they find the content useful. Comments on the text are welcome and should be addressed to the author care of Bloomberg Press.
Top of Page |
|
|
|
|
|
|
|
|
|
|
