Risk-Return Characteristics
When the underlying share price is well below the conversion price, the convertible bond exhibits mostly bond risk-return characteristics and is described as a busted convertible. Therefore, the bond will be sensitive to interest rate movements and credit spreads, just…
Time Structure Models
Equilibrium Term Structure Models Equilibrium term structure models are built on theories about the economy. They explain the stochastic process that describes the dynamics of the yield curve (term structure). They are primarily based on macroeconomic variables. That includes inflation,…
Uses of CDS
Investors exploit the arbitrage opportunities created by the differences in pricing between asset and CDS markets, or differences in pricing of different products in the market. Credit Basis A CDS basis is the difference between a bond’s credit spread and…
Use of CDS to Manage Credit Exposures
The credit curve shows the credit spreads over a risk-free benchmark rate for a range of maturities of a firm’s debt. A credit spread rewards bondholders for assuming credit risk. The shape of the CDS credit curve can be explained…
Market Price of CDS
The value of a CDS depends on the probability of default, i.e., the likelihood of non-payment of promised interest and/or principal on a bond. The default probability typically increases with time. However, in a CDS context, the probability of default…
Credit Events
A credit event is an event that triggers the default of a bond. The CDS seller must purchase the defaulted bonds at their face value from the CDS buyer in case of a credit event. The International Swaps and Derivatives…
Study Notes for CFA® Level II – Fixed Income – offered by AnalystPrep
Reading 28: The Term Structure and Interest Rate Dynamics -a. Describe relationships among spot rates, forward rates, yield to maturity, expected and realized returns on bonds, and the shape of the yield curve; -b. Describe how zero-coupon rates (spot rates)…
Pricing using the Zero-Coupon Yield Curve and an Arbitrage-Free Binomial Lattice
Valuing a fixed-rate coupon bond with no embedded options using the arbitrage-free lattice and the spot curve leads to the same bond value. This holds because the binomial interest rate tree is arbitrage-free. However, the spot curve will not work…
Structure and Features of Credit Default Swaps (CDS)
A credit derivative is an agreement between two parties, a credit protection buyer and a credit protection seller. The protection seller provides protection to the buyer against a particular credit loss. Among the various types of credit derivatives, credit…
Credit Analysis for Securitized Debt
Securitized debt allows the issuers to finance a specific set of assets such as mortgages and auto loans rather than the entire balance sheet, unlike other risky bonds. Investors of securitized debt benefit from greater diversification, more stable and predictable…
