Overview

The introduction of the euro in 1999 marked the starting point of the development of a very liquid and heterogeneous EUR credit market, which exceeds EUR 350bn with respect to outstanding corporate bonds. As a result, credit risk trading and credit portfolio management gained significantly in importance. The book shows how to optimize, manage, and hedge liquid credit portfolios, i.e. applying innovative derivative instruments. Against the background of the highly complex structure of credit derivatives, the book points out how to implement portfolio optimization concepts using credit-relevant parameters, and basic Markowitz or more sophisticated modified approaches (e.g., Conditional Value at Risk, Omega optimization) to fulfill the special needs of an active credit portfolio management on a single-name and on a portfolio basis (taking default correlation within a credit risk model framework into account). This includes appropriate strategies to analyze the impact from credit-relevant newsflow (macro- and micro-fundamental news, rating actions, etc.). As credits resemble equity-linked instruments, we also highlight how to implement debt-equity strategies, which are based on a modified Merton approach. The book is obligatory for credit portfolio managers of funds and insurance companies, as well as bank-book managers, credit traders in investment banks, cross-asset players in hedge funds, and risk controllers.

Full Product Details

Author:   Jochen Felsenheimer ,  Philip Gisdakis ,  Michael Zaiser
Publisher:   Wiley-VCH Verlag GmbH
Imprint:   Blackwell Verlag GmbH
Dimensions:   Width: 16.30cm , Height: 4.00cm , Length: 23.80cm
Weight:   1.021kg
ISBN:  

9783527501984

ISBN 10:   3527501983
Pages:   581
Publication Date:   13 December 2005
Audience:   Professional and scholarly ,  Professional & Vocational
Format:   Hardback
Publisher's Status:   Out of Print
Availability:   In Print  
Limited stock is available. It will be ordered for you and shipped pending supplier's limited stock.

Table of Contents

Foreword 13 Introduction and Acknowledgements 17 Part I Markets 19 1 Market Structure 21 1.1 Market Development 22 1.1.1 Historical Development 22 1.1.2 Size and Growth of the Market 27 1.2 Market Participants 27 1.2.1 Banks 28 1.2.2 Insurance Companies 29 1.2.3 Funds and Asset Managers 30 1.2.4 Retail Clients 30 1.2.5 Hedge Funds 30 1.3 Issuing Debt from a Company’s Viewpoint 31 1.4 Ratings and Rating Agencies 33 1.4.1 Are Ratings an Efficient Source for Pricing Credits? 36 1.5 Credit Classes 39 1.5.1 High-Grade Universe 39 1.5.2 High-Yield and Crossover Credits 40 1.5.3 High-Quality Segment 41 1.5.4 Asset Backed Securities 42 2 Instruments 45 2.1 Straight Bonds 45 2.2 Bonds with Embedded Options 47 2.3 Exotics 48 2.3.1 Payment-in-Kind Notes 49 2.3.2 Hybrids or Subordinated Corporate Bonds 50 2.4 Hybrid Bank Capital 53 2.5 Single-Name Credit Derivatives 55 2.5.1 Credit Default Swaps 55 2.5.2 Digital Default Swaps 58 2.5.3 Equity Default Swaps 58 2.5.4 Recovery Default Swaps 60 2.5.5 Constant Maturity Credit Default Swaps 61 2.6 Portfolio Credit Derivatives 62 2.6.1 Basket/Index Swaps – iTraxx Europe Benchmark 62 2.6.2 Default Baskets 65 2.6.3 Standardized iTraxx Tranches 67 2.6.4 Spread Options 68 2.6.5 Future Contracts 70 2.7 Outlook on Product Development 70 3 Company and Debt Instrument Analysis 73 3.1 Sovereign Risk and Government Support 74 3.2 Business Risk 74 3.3 Financial Risk 82 3.3.1 Off-Balance-Sheet Adjustments 86 3.3.2 Adjustment of Ratios 91 3.4 The Rating Agencies’ Methodology 93 3.5 Evaluation of Specific Debt Instruments 96 3.6 Recovery Rate Estimates 99 4 The Economics of Credit Spreads 103 4.1 Macro Drivers 103 4.1.1 Credits in the Business Cycle 103 4.1.2 Yields and Spreads 106 4.1.3 Credits and Exchange Rates 108 4.1.4 Credits and Commodity Prices 109 4.1.5 Credits and Inflation 111 4.1.6 Credits and External Shocks 113 4.2 Micro Drivers 115 4.3 Credit Quality 117 4.3.1 Credit Quality Trend 117 4.3.2 Default Rates 117 4.3.3 Recovery Rates: The Collins & Aikman Case 120 4.3.4 Implied Ratings 122 4.4 Equity–Debt Linkage 123 4.4.1 The Basic Merton Approach: Structural Models 123 4.4.2 Merton in Practice 128 4.4.3 Leap-Put Skewness as an Equity–Debt Indicator 131 4.4.4 Empirical Evidence for the Equity–Debt Linkage 133 4.5 Market Technicals 136 4.5.1 Is there a New Issuance Premium? 137 4.5.2 Technical Bid 138 4.5.3 The Impact of Syndicated Loans on Corporate Bonds 139 Part II Models 141 5 Fixed Income Basics 143 5.1 Basic Valuation Concepts 143 5.1.1 The Discount Function 143 5.1.2 Spot Rates and the Term Structure of Interest Rates 149 5.1.3 Forward Rates 154 5.2 Obtaining the Term Structure of Interest Rates 158 5.3 The Yield to Maturity 159 5.4 Measurement of Interest Rate Risk 162 6 Spread Measures 171 6.1 Basic Considerations 171 6.2 Yield Spreads 173 6.3 Z-Spreads 177 6.4 Asset Swap Spreads 180 6.5 Spread Measures for Floaters 184 6.6 Spreads and the Real Economy 186 6.7 Conclusion 192 7 Basics of Credit Risk Models 195 7.1 The Components of Credit Risk 196 7.2 A Single-Step, Two-Stage Model 198 7.3 A Multi-Step Model for Zero Coupon Bonds 202 7.4 The Multi-Step Model 208 7.5 Continuous-Time Approach 210 7.6 Recovery Treatment 217 7.6.1 Fitch’s Recovery-Rating Methodology 228 7.7 The Term Structure of Credit Spreads 231 8 Single-Name Models 237 8.1 Reduced-Form Models 238 8.1.1 Binomial Tree Models for Default Risk 244 8.1.2 Reduced-Form Models and Illiquid Claims 249 8.2 Structural Models 250 8.3 Rating-Based Transition Matrix Models 260 8.3.1 Redefining the Default Event 265 9 Portfolio Models 271 9.1 The Loss Distribution and its Impact on Portfolio Derivatives 273 9.2 Independent Defaults 276 9.3 Default Dependency 282 9.4 Term-Structure Effects 288 9.5 Valuing First-to-Default Baskets 289 9.6 Valuing CDO Tranches with the HLPGC Model 292 9.7 Spread Dispersion 296 9.8 Price Discovery versus Model Competition 300 10 Valuation of Credit Derivatives 303 10.1 Credit Default Swaps 304 10.1.1 Discrete-Time Model 305 10.1.2 Obtaining the Survival Probability Curve 311 10.1.3 Forward CDS Valuation 314 10.1.4 CDS Sensitivities 316 10.1.5 Continuous-Time Model 318 10.1.6 Bloomberg’s CDSW Function 319 10.2 Options on Credit-Risky Instruments 322 10.2.1 Single-Name Credit Default Swaptions 323 10.2.2 Index Swaptions 326 10.3 CDS Indices 327 10.4 nth-to-Default Baskets 330 10.5 Collateralized Debt Obligations 337 10.5.1 Standardized iTraxx Tranches 338 10.5.2 Compound and Base Correlation 341 10.5.3 Sensitivities of iTraxx Index Tranches 346 10.6 Exotic Derivatives 357 10.6.1 Equity Default Swaps 357 10.6.2 Constant Maturity Structures 358 10.6.3 Digital Default Swaps and Recovery Swaps 360 11 Portfolio Risk Measurement 365 11.1 Risk Measures 365 11.1.1 Market Risk versus Credit Risk 365 11.1.2 Value at Risk and Conditional Value at Risk 367 11.1.3 Risk Components 372 11.2 Credit Portfolio Models 373 Part III Management 377 12 Principles of Credit Portfolio Management 379 12.1 The Role of ACPM in the Asset Allocation Process 379 12.2 Management Styles: Passive or Active 386 12.2.1 Passive Management 386 12.2.2 Active Management 388 12.3 Quantitative and Fundamental Credit Research 389 12.4 Diversification in Credit Portfolios 391 12.5 Credit Risk Management in an ALM Environment 393 12.6 Credits in the Global Asset Allocation 394 12.6.1 Increasing Importance of Credit-Risky Instruments 394 12.6.2 Credits, Government Bonds, and Equities 395 12.7 Building Blocks of Credit Portfolio Management 397 12.7.1 Step 1: Investment Targets 398 12.7.2 Step 2: Risk Factors 400 12.7.3 Step 3: Economic Variables 401 12.7.4 Step 4: Forecasting and Scenario Assessment 401 12.7.5 Step 5: Sensitivities 402 12.7.6 Step 6: Portfolio Optimization Analysis 403 12.7.7 Step 7: Portfolio Adjustments 404 12.7.8 Step 8: Performance Analysis 405 12.8 Key Portfolio Figures 406 13 Portfolio Allocation 409 13.1 Indices 410 13.1.1 The Function of Indices 410 13.1.2 The iBoxx € Index Universe 411 13.1.3 Analyzing the RDAX 413 13.2 Sector Allocation in a Markowitz Framework 418 13.3 Quality Allocation 421 13.4 Tools to Derive the Optimal Allocation 424 13.4.1 Alpha and Beta 425 13.4.2 The Shortcomings of a Beta Analysis 425 13.4.3 Aggregated Z-Scores 427 13.4.4 Equity Volatility as a Tool in the Allocation Process 428 14 Performance Measures 431 14.1 Tracking Error 432 14.2 Sharpe Ratio and Treynor Ratio 433 14.3 Information Ratio 435 14.4 Summary 436 15 Performance Analysis 437 15.1 Return Accumulation 437 15.2 Return Attribution Analysis 438 16 Hedging Credit Risk 443 16.1 Hedging on a Single-Name Level 443 16.1.1 Basic Considerations 443 16.1.2 Hedging Default Risk 445 16.1.3 Hedging Spread Risk 448 16.2 Hedging on a Portfolio Level 452 16.2.1 Basic Considerations 453 16.2.2 Hedging Systematic Spread Risk for a Single Cash Bond 453 16.2.3 Hedging Systematic Spread Risk for a Credit Portfolio 458 16.2.4 Finding the Right Hedging Instrument 462 17 Trading Strategies 469 17.1 Trading Cash Bonds 469 17.2 Trading Strategies with Single-Name CDS 472 17.2.1 Plain-Vanilla CDS Trades 474 17.2.2 Switch Ideas 474 17.2.3 Curve Trades 475 17.3 Portfolio Derivatives Trades 476 17.3.1 Single Name versus Sector or Market 476 17.3.2 Core–Satellite Strategies 477 17.3.3 Sector and Segment Trades 478 17.3.4 Trading the Skew 479 17.3.5 Basis Trades 481 17.3.6 First-to-Default Baskets 482 17.3.7 iTraxx Tranches versus Default Baskets 485 17.3.8 Playing the Steepness of the iTraxx Curve 488 17.4 Spread Options: Single and Complex Strategies 489 17.5 CPPI Strategies Including iTraxx Indices 490 17.6 Correlation Trading 492 17.7 Capital Structure Arbitrage Trades 494 17.8 Recovery Trades 495 17.9 EDS versus CDS and the Role of DDS 496 17.10 CDS–Cash–Repo Arbitrage 500 17.10.1 The Repo Market 500 17.10.2 How an Arbitrage Trade Works 501 18 Operational Issues: Accounting 503 18.1 An Introduction to IAS 39 504 18.1.1 The Scope of IAS 39 504 18.1.2 Categories of Financial Instruments 505 18.1.3 Measurement 507 18.1.4 Recognition and Derecognition 512 18.1.5 Embedded Derivatives 513 18.1.6 Hedge Accounting 515 18.2 IAS 39 Accounting for Credit Instruments 518 18.2.1 Bonds and Loans 518 18.2.2 Credit Default Swaps 521 18.2.3 Total Return Swaps 523 18.2.4 Credit Linked Notes 525 18.2.5 iTraxx Products 526 18.2.6 Other Instruments of Interest 527 19 Operational Issues: Basel II 529 19.1 An Introduction to Basel II 529 19.1.1 The Basic Structure 529 19.1.2 The Standardized Approach 533 19.1.3 The Foundation IRB Approach 534 19.1.4 The Advanced IRB Approach 538 19.1.5 Securitization Transactions 540 19.1.6 Credit Risk Mitigation 543 19.2 Basel II for Credit Instruments 547 19.2.1 Credit Default Swaps 547 19.2.2 Total Return Swaps 550 19.2.3 Credit Linked Notes 551 19.2.4 Default Baskets 553 19.2.5 iTraxx Products 555 Part IV Appendix 557 A.1 Analytics with Bloomberg and Reuters 559 A.1.1 Bloomberg 559 A.1.2 Reuters 560 A.2 Default and Recovery Data from Rating Agencies 563 References 569 Index 575

Reviews

It nicely combines the practical aspects with the relevant theoretical framework...appealing to academics in finance. (Financial Markets Portfolio Management Journal, July 2006)

"""It nicely combines the practical aspects with the relevant theoretical framework...appealing to academics in finance."" (Financial Markets Portfolio Management Journal, July 2006)"

Author Information

Dr. Jochen Felsenheimer works for HVB Corporates & Markets and is currently heading the Credit & Credit Derivatives Strategy team, a department of HVB Global Markets Research. He holds a PhD in Economics from Ludwigs-Maximilians-Universität München. Dr. Philip Gisdakis is a Quantitative Credit Strategist. He studied Mathematical Finance at the University of Oxford and holds a PhD degree in Theoretical Chemistry from Technische Universität München. Michael Zaiser is a Credit Strategist at HVB Corporates & Markets. He studied Business Administration and Mathematics at Johann Wolfgang Goethe-Universität Frankfurt am Main.

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