The Structured Credit Handbook

by Rajan, Arvind; McDermott, Glen; Roy, Ratul

• ISBN13: 9780471747499
• ISBN10: 0471747491
• Edition: 1st
• Format: Hardcover
• Copyright: 2007-02-09
• Publisher: Wiley

Summary

The Structured Credit Handbook is a comprehensive introduction to all types of credit-linked financial instruments. This book provides state-of-the-art primers on single tranche collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), credit derivatives (such as credit default swaps and swaptions), and iBoxx indexes. Filled with in-depth insight and expert advice, The Structured Credit Handbook covers all aspects of the synthetic arbitrage CDO market, including new instruments such as CDO2. Readers will also gain a firm understanding of the investment rationale, risks, and rewards associated with CDO investments through this valuable resource. The exploding use of credit derivatives and collateralized debt obligations (CDOs) has transformed the world of credit, creating an $18 trillion market almost overnight and resulting in innumerable investment and career opportunities globally. The Structured Credit Handbook provides the reader with a comprehensive and clear roadmap to today's new credit landscape. The full spectrum of structured credit products, from single-name CDS to CDOs, is explained in a simple, clear fashion that is free from the financial jargon and mathematical complexity which characterize many other derivative texts. The handbook begins with an in-depth explanation of the building blocks of the structured credit markets, single-name default swaps and indexes, and it culminates with complex products such as credit options, synthetic tranches, CDOs based on bank loans and asset-backed securities, and CDO-squareds. Written by experienced practitioners who have participated in this market since its infancy, each of the thirteen chapters introduces and analyzes a new product and explains its practical applications. A rich set of real-life case studies illustrate the application of each product in a concrete market setting. The book may be used in a semester-long course on structured credit as part of a business or finance curriculum. Whether you are a market professional, a university student or faculty member, or simply a financially savvy layperson, look no further for an up-to-date and thorough introduction to this rapidly growing and exciting field. Dr. Arvind Rajan, Managing Director, Citigroup Global Markets, is engaged in proprietary trading of Structured Credit products, and until recently, was global head of Structured Credit Research and Strategy at Citigroup. Glen McDermott (New York, NY) is Director of Fixed Income Sales and the former head of CDO Research at Citigroup Global Markets Inc. Ratul Roy is head of CDO Strategy for Citigroup Global Markets and has spent the prior nine years in structuring or analyzing CDOs and other structured credit products.

Author Biography

Dr. Arvind Rajan is Managing Director in the Relative Value Group of Citigroup's Global Fixed Income Division, where he engages in proprietary trading of Credit, Structured Credit, and Emerging Markets. For the past 13 years, Arvind has held a number of senior positions at Citigroup and Salomon Brothers, including Co-head of US Fixed Income Strategy, Global Head of Structured Credit Research and Strategy, and Global Head of EmergingMarkets Quantitative Strategy. Arvind was twice ranked first and once second in the All-America Fixed Income Research poll conducted annually by Institutional Investor magazine. In all, Arvind has two decades of experience in modeling and quantitative analysis, including a stint at Bell Laboratories and as a faculty member in the Mathematical Sciences Department at Rice University. He holds a Ph.D. and M.S. in Operations Research from Northwestern University, and a bachelor’s degree from the Indian Institute of Technology, Chennai, India.

Glen McDermott, J.D., is a Director in the Structured Credit Sales Group at Citigroup Global Markets, Inc., where he sells credit derivatives and collateralized debt obligations to a wide array of institutional fixed income clients. Previously, Glen was a highly ranked research analyst and Global Head of CDO Research and Strategy at Citigroup (2000-2005), where he led a five-person team dedicated to analyzing a multitude of structured credit products, both cash and synthetic. Prior to joining Citigroup, Glen worked for 6 years (1994-2000) at Standard & Poor's Ratings Services where he analyzed many structured finance asset classes including mortgage-backed securities, credit card ABS and CDOs. Glen's work has been published in numerous scholarly journals, including The Journal of Portfolio Management, The Journal of Fixed Income, and The Journal of Structured Finance. He is also a contributor to Salomon Smith Barney Guide to Mortgage-Backed and Asset-Backed Securities (John Wiley & Sons, 2001). Glen received his B.A. degree from the College of the Holy Cross and his J.D. from Fordham University School of Law.

Ratul Roy is head of CDO Strategy for Citigroup Global Markets. Before taking on his current role in 2005, Ratul was head of European CDO Strategy--a position he occupied in 2003 after spending the prior seven years in structuring or analyzing CDOs and other structured credit products.
This included positions in UBS Capital Markets (1995-1997), Chase Manhattan Bank (1997-1999), Standard and Poor, and finally, as a cash CDO structurer in Citigroup's London office (2000-2003).
Ratul has a Ph.D. in chemical engineering from Cambridge University, England.

Table of Contents

Acknowledgments

About the Authors

About the Contributors

Introduction: A Roadmap of the New World of Structured Credit

How Structured Credit Completes Markets

Enabling Technology

Improved Liquidity, Transparency, and Customizability

Growth of Structured Credit Markets

Asset Classes

Products

Participants

Core Uses of Structured Credit

Nonrecourse Leverage

Diversification 8

Customization of Risk Profiles

Separating Legal from Beneficial Ownership

Separating Funding from Risk Transfer

Isolating and Hedging Risk

Representative Examples of Structured Credit Solutions

Who Should Read This Book?

How This Book Is Organized

Index and Single-Name Products

A Primer on Credit Default Swaps

The Market for Credit Default Swaps

Transaction Terminology and Mechanics

Prerequisites for Credit Derivatives Transactions

What Happens in Case of a Credit Event?Unwinding Default Swap Transactions

The DV01 of a Credit Default Swap

The Default-Cash Basis

Some Uses of Default Swaps

Buying a Note versus Selling Default Protection

Freeing Up or Using Bank Credit Lines

Filling a Maturity Gap

Expressing Curve or Forward-Rate Views

Barbell-Bullet Trade

Taking Advantage of Tight Repo Levels without Financing

Case Study: Relative Value_Cashing In on the Curve Steepness in Telecoms

How to Blend CDs and Cash in Long-Maturity-Curve Trades

Implementing Credit Curve Flatteners_Two Basic Approaches

Appendix: Equivalence of a Bond Spread and Default Swap Premium

Specialness of the Underlying

Effect of Accrued Default Swap Premium

Accrued Interest on the Underlying Risky Security

Accrued Interest on the Underlying Risk-Free Security

Credit Default Swaptions

Constant Maturity Credit Default Swaps

Basics of CMCDSs

Participation Rate

Behavior of CMCDSs

Impact of Spread Level

Impact of Spread Volatility

Capped CMCDS

Hedging CMCDSs

Trading Strategies with CMCDSs

Selling CMCDS Protection

Buying CMCDS Protection

Combination Trades and Index CMCDSs

Conclusion

Case Study: Taking Curve Views with CMCDSs

Features of CMCDSs

Trade Ideas

Appendix: Computing the Participation Rate

Credit Derivatives Indexes

Introduction

Family of Credit Derivatives Indexes

Structure of the CDX/iTraxx Index Family

Administration of Indexes

Basket of Credit Default Swaps

Trading Example_The Index

Up-Front and Running Payments

Trading Example_Premium Payments

What Happens in Case of a Credit Event?Trading Example_Credit Event

Settlement Process after Credit Event

Physical Settlement (Indexes and Tranche Products)

Cash Settlement (Tranche Product Only)

Recent Defaults in CDX Indexes

Index versus Intrinsics

Investment Strategies with Credit Derivatives Indexes

Investors

Index-Related Structured Credit Products

Issues and Concerns

Conclusion

Case Study: DJ CDX HY and DJ CDX EM_Conversion of Price Level into a Spread Level

Case Study: Using iTraxx to Replicate Bond Portfolios

Motivation

Typical Portfolio Risks

Replicating Interest Rate Risks

Using iTraxx to Replicate Broad Credit Market Risk

Adjusting for Single-Name Risk through Default Swaps

Performance

Conclusion

Appendix: Description of the Roll Process

Risky PV01 of a CDS Contract

Calculation of Intrinsic Spread of the Index

Risky PV01 of an Index

Mark-to-Market Estimation of an Index Position

The Added Dimensions of Credit_A Guide to Relative Value Trading

Overview of Curve Trades

Lear

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