Download Credit Derivatives Handbook - Volume 1 by Merrill Lynch PDF

By Merrill Lynch

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Example text

At initiation, the PV of all the cashflows must be zero. As such, the asset swap spread satisfies the following equation (from the perspective of the asset swap seller): M Fixed payments on IR swap 0 = 100−P + ∑ M C×di − i=1 ∑ (L +A)×d ×α i i i i=1 Floating payments on IR swap Where, P is the cash price of the bond, A is the Par-ASW spread, di is the ith discount factor (derived from swap market), Li is the ith LIBOR rate set at time ti-1 and paid at time ti, C is the bond’s coupon, αi is the accrual factor in the appropriate daycount basis.

Refer to important disclosures on page 118. 31 Credit Derivatives Handbook 2006 – Vol. 1 – 14 February 2006 • Investor expects a credit event after that implied by the market: The investor would prefer to (a) sell protection on a running basis, or (b) buy protection on an upfront basis. Table 12: Relative Performance of an Upfront and Running CDS as a Function of Credit Event Timing Protection Buyer Prefers Credit Event in the Credit Event in the Near-Term Longer-Term × × Upfront CDS Running CDS Protection Seller Prefers Credit Event in the Credit Event in the Near-Term Longer-Term × × Source: Merrill Lynch Case Study: Basis Trading With Upfront CDS Upfront CDS can also be used in basis strategies .

Each cash flow is discounted at the appropriate rate based upon when it will be paid. To say it another way, Z is the single number which, when added to each point on the swap curve, produces a discount curve that yields the current price of the bond when used to discount all the bonds cash-flows. This number is calculated through an iterative process. Because it uses the entire yield curve to value the cash flows rather than just a Refer to important disclosures on page 118. 41 Credit Derivatives Handbook 2006 – Vol.

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