Credit strategy Flashcards
interpolated benchmark
use of the most liquid, on-the-run government bonds to derive a hypothetical x-year UK gilt YTM
effective spread duuration
it has equation look like effective duration
CVA
Credit valuation adjustment: present value of credit risk
default risk
probability of default:
+ likelihood that :
+ a borrower defaults or fails to meet its obligation to make full and timely payments of principal and interest
+ according to the terms of the debt security
loss severity
+ loss given default - LOD: amount of loss if default occurs
+ expressed as % of par value
credit loss rate
represents the realized percentage of par value lost to default for a group of bonds = the bonds’ default rate x the loss severity
credit migration
likelihood of change in rating of public bond, usually has a negative effect to bond prices
credit cycle
cycle of credit, should learn by heart the table
G-spread
use interpolate from gov yield
Adv:
+ transparent & maturity matching with default risk free bond
Disadv:
+ Subject to change in gov bond demand
I-spread
interpolated spread: spread use interest rate swap as a benchmark = yield - swap rate
Adv:
+ used as hedge or carry trade
Disadv:
+ Point estimate of term structure (resolve in Z-spread)
+ Limited to option-free bond
asset swap spread
= bond fixed coupon rate - MRR (market reference rate)
Adv:
+ Use in traded spread: coupon <> MRR + spread
Disadv:
+ Tradable spread rather than spread measure coresponding to CF
+ Limited to option free bond
zero-volatility spread (Z-spread)
the spread add to the discount to help the bond price equal market price
Adv: capture term structure
Disadv:
+ more complex calculation
+ limited to option free bond
Credit default swap (CDS) basis
= Z-spread on a specific bond - the CDS spread of the same (or interpolated) maturity for the same issuer.
Adv: Interpolated CDS spread & Z-spread
Disadv:
+ traded rather than measure corresponding
+ Limited to option free
option-adjusted spread (OAS)
a generalization of the Z-spread calculation that incorporates bond option pricing based on assumed interest rate volatility:
Adv: can compare option free bond to embedded option
Disadv:
+ complex
+ not stable overtime
discount margin (DM)
Additional return because of risky asset
zero-discount margin (Z-DM)
When price = par
effective spread convexity
like convexity but related to delta spread
spread duration
= - (effSpreadDu x deltaspread) + 1/2 x EffSpreadCon x (delta Spread)^2
OAS duration
= - (effSpreadDu x deltaspread) + 1/2 x EffSpreadCon x (delta Spread)^2
Duration Times Spread (DTS)
DTS ≈ (EffSpreadDur × Spread)
Excess Spread
= Spread x t - EffSpreadDu x Delta Spread
Expected excess spread return
= Spread x t - EffSpreadDu x Delta Spread - 1/2 EffSpreadCon x (deltaSpread)^2
Effective Spread Duration
like Effective Duration but replace yield by Delta MRR (Market reference rate)
Effective Spread Duration
look like Effective Duration by replace yield by Delta DM (discount margin)
Structural credit model
+ use market-based variables to estimate the market value of an issuer’s assets and the volatility of asset value.
+ The likelihood of default is defined as the probability of the asset value falling below that of liabilities.
reduce form model
solve for default intensity, or the POD over a specific time period, using observable company-specific
variables such as:
+ financial ratios
+ recovery assumptions
as well as macroeconomic variables, including:
+ economic growth
+ market volatility measures
Default intensity
it is hazard rate, the probability of default for a certain time period conditional on no earlier default
bottom-up credit strategy
finding the best issuer/individual bond investment rather than focus on macro-enviroment
+ Step 1: identify universe of bond relevant to mandate
+ Step 2: divide universe into sectors such as undustry/ geography
+ Step 3: looking for relative misvaluation to determine securities to select
Credit analysis is assessment the likelyhood of issuer making scheduled principal + interest payment, include:
+ Operating history + competitive position of the issuer
+ Financial ratio include: profitability, leverage, coverage ratio
Top-down credit strategies
+ focus on macro factors that affect the credit portfolio (strength of economic growth, corporate profits)
+ Use:
* indentify when focus on HY / IG
* sectors most likely to improve -> can overweight this factors
factor-based credit strategies
use style-based factors, identify as offering risk premium in coporate bond investing.
4 factors:
+ Carry -> OAS
+ Defensive: -> risk adjust return
+ Momentum: outperform go on to outperform in the future
+ Value
conditional Var
expected loss
incremental VaR
impact of change in portfolio position
relative VaR
measure expected tracking error versus benchmark portfolio
CDS Price
= 1 + (Fixed Coupon - CDS Spread) x EffSpreadDu
CDS curve
plot of CDS spread across maturities
static Credit spread curve strategy
hypothesis: credit spread curve remain unchange
method:
+ lowering the average credit rating of bond portfolio
+ increasing spread duration by buy + hold longer-dated bond
+ sell protection
Dynamic credit spread strategy
base on credit cycle to buy/sell bond/protection
Global credit strategy
based on:
+ diversify through investing in different sectors
+ sector difference exist between developed market
+ difference in accounting standard
+ difference in credit manitude & timing related to credit cycle
credit structured
CDOs, CLOs, MBS, ABS, Covered Bonds
user-defined parameter
include:
+ models for term structure, risk,
+ scenario analysis
+ filter for include/exclude bonds by sectors/ESG ratings.
rule to immunize a single liability
(1) portfolio market value (PVA) equals (or exceeds) PVL
(2) Portfolio Macaulay duration matches the due date of the liability (DA = DL)
(3) Minimize portfolio convexity (to minimize dispersion of asset cash
Matching issuer exposure weights
to control for specific event risk affecting only that issuer, such as bankruptcy
bums problem
bum is a less creditworthy issuer
Immunized Portfolio Convexity
= (Mac Du ^2 + Mac Du + Dispersion) / (1 + CF Yield)^2
money duration
A measure of the price change in units of the currency in which
the bond is denominated. Money duration can be stated per 100
of par value or in terms of the bond’s actual position size in the
portfolio
BPV = Money Du x 0.01%
dollar duration
it is money duration
Duration drift
Duration drift is the change of duration due to the passage of time
Eg: The duration drift has arisen because of a widening spread between corporate and government bond yields as interest rates in general have come down.
Butterfly spread
butterfly spread is equal to twice the medium-term yield
minus the short-term and long-term yields,
Butterfly spread
butterfly spread = 2 x the medium-term yield - (the short-term + long-term yields)
+ Humped
+ Sauce
+ butterfly spread / butterfly /twist
Immunizing with coupon-bearing bonds
continuously matching the portfolio Macaulay duration with the Macaulay duration of the zero-coupon bond over time and as the yield curve shifts, even though the zero-coupon bond could be hypothetical and not exist in reality
A duration-neutral flattening trade
involves a short short term bond position and a long long term bond position, which have a “matched” duration or portfolio duration of zero
Flight to quality
Thị trường sập, quay sang mua tài sản tốt
market stress scenario, investors sell high-risk, low-rated bonds, which fall in price, and purchase government bonds, which experience price appreciation
roll down return vs rolling yield
Rolling yield = roll down return + coupon income
goals of credit strategies
choose maximize credit spread
across issuer types, industry,…
within predescribe investment mandate
method to hedge the tail risk
Reduce tail risk:
+ Position limits
+ Risk budgeting
Hedge tail risk:
+ Swaption
+ CDS
QM (description, Adv, disadv)
- Description: Yield of original FRN - MRR
- Advantage: Represents periodic spread related FRN cash flow
- Disadvantage: Does not capture changes in credit risk over time
DM (description, Adv, disadv)
- Description: Yield to price FRN at par - MRR
- Advantage: Establishes spread difference from QM with constant MRR
- Disadvantage: Assumes a flat MRR zero curve
Z - DM (description, Adv, disadv)
- Description: Yield spread over MRR curve
- Advantage: incorporate forward MRR rates in yield spread measure
- Disadvantage: more complex calculation and yield spread does not match FRN cash flow
The meaning of Credit excess spread return
(1) negative is not efficiency
(2) higher excess spread return -> more attractive
CDOs (description, exposure, application)
(1) Description: backed by a diversified pool of debt obligations
(2) Exposure: Redistribute portfolio debt cash flows across ratings spectrum
(3) Create tailored portfolio-based debt exposure categories/profiles unavailable in the cash bond market
CLOs (description, exposure, application)
(1) Description: backed by a diversified pool of floating-rate leveraged loan obligations.
(2) Exposure: Redistribute portfolio loan
cash flows across ratings spectrum. (like CDOs)
(3) Create tailored portfolio-based debt exposure categories/profiles unavailable in the cash bond market (like CDOs)
MBS (description, exposure, application)
(1) Description: a pool of commercial or residential mortgage loans.
(2) Exposure: Provide portfolio-based exposure to real estate cash flows
(3) Offer active managers exposure to real estate and to volatility (prepayment/extension risk) unavailable in the cash bond market
ABS (description, exposure, application)
(1) Description: pool of credit card, auto, and other loans
(2) Exposure: Provide portfolio-based exposure to consumer loan cash flows
(3) Offer active managers direct exposure to consumer loans and to volatility unavailable in the cash bond market
Covered Bonds
(1) Description: Senior debt obligations backed by pool of commercial/residential mortgages or public sector assets
(2) Exposure: Provide portfolio-based exposure to real estate cash flows with recourse to issuer (dual recourse)
(3) Offer active managers direct exposure to consumer loans and to real estate/public sector cash flows unavailable in the cash bond market
dual recourse
specify by covered bond (bảo vệ 2 lần)
how to increase convexity
(1) Long putable, Long calls, Puts
(2) Short callable, short MBS
Standardized of Fixed coupon HY CDS contract and IG CDS contract
IG CDS contract: 1%
HY CDS contract: 5%
