Secondly, it presents a review of sensitivities and spillover effects on CDS spreads from bond, equity and options markets. Under this, the market that has the greatest influence is identified after considering statistical evidence from various sources. Finally, the report reviews credit default swaps in the context of monitoring sovereign risks in both developed and emerging market economies. This seeks to demonstrate how credit default spreads behave in tranquil and volatile market environments. In addition, the importance of CDS market development in emerging economies is also highlighted in this report. 2.0 Background Credit default spreads (CDS) are recent innovation in the management of credit risks. They have gained popularity in the management of both single name and sovereign debt risks. The market is valued based on information from related underlying equity, bond and their options markets. However, various challenges have been experienced when dealing with CDS markets. These challenges include pricing of CDS spreads, lack of exchanges for trading credit derivatives, manipulation of accounting information, among others. Pricing of the CDS spreads is not an easy task. Though various models have been put forward by many researchers, there is no universally accepted method of computing the price of CDS. Another challenge is the lack of exchanges for trading credit derivatives. CDS quotes are therefore obtained over the counter (OTC) and may not be reliable for estimating the CDS spreads. Spillover effects from the bond, equity, and options markets also affect the CDS spreads. The extent to which these markets impacts on the CDS spreads is not clearly known despite the various statistical methods posted by different researchers. Some suggested that equity markets have the greatest spillover effects on the CDS spreads while others argued that options market are the major contributors. Credit default swaps have been fully taken up in the developed economies while the emerging economies are still struggling to catch up. The way in which CDS behaves in tranquil and volatile market environments has sparked serious research. Many questions concerning CDS markets and their importance in the emerging economies have been raised by various researchers. How are sovereign risks managed by these economies? The application CDS in managing risks is a new innovation that requires further research. 3.0 Credit Default Swaps 3.1 Determination of the price of a single name CDS security. Many approaches of determining CDS spreads have been put forward by various researchers. One commonly used approach for pricing a derivative is by finding a portfolio of assets whose returns matches that of the derivative replicated. Duffie & Singleton (2003) and Lando (2004) suggested such portfolios in their research. This strategy may not work in a situation where similar replicating instruments needed for replicating the portfolio are not issued by the issuer whose CDS’s are being replicated. In addition, what happens to the replicating portfolio when the CDS contract ends after a credit event? Another approach of pricing CDS spreads is to determine the value of spread which equates the net present value of the expected value of the coupon to the net present value of the expected value of the payoff. Hull & White (2001) used this approach to formally derive the pricing formula. They assumed that interest rates, recovery rates and default
Credit Default Swap (CDS) Name: Instructor: Course: Date: 1.0 Executive Summary This report examines credit default swap (CDS), which is a recent innovation in the management of credit risks. It is a critical review report which deals with pricing, valuation and sensitivities of CDS spreads…
Due to their flexibility, derivatives allow the investor to explore a full range of investment strategies. This includes hedging, speculation and arbitrage. In addition to this, derivatives offer sophisticated management of risk. They allow for gearing or what is known as leverage.
The Nature of the Credit Default Swap CDS refers to the process of a buyer paying consecutively to a retailer of merchandise to have his protection from the predicted fall in sales of a credit mechanism like the credit bonds of an institution. When credit mechanism occurs to an institution, the purchaser of the mechanism has the sole security of the making sure the bonds are security of the seller is retained.
It was incorporated in the United Kingdom and trades its shares in the London Stock Exchange (LSE). The company dates back to 1885, when William Lever together with his brother established a soap manufacturing company and named it Lever Brothers. They started by manufacturing Sunlight, the first packaged soap which was very successful upon being launched in the market.
The use of its products and services ranges from home to businesses and on the road. BP product lines include bio fuels, gas and fuel cards, industrial lubricants, marine fuels, Liquefied Petroleum Gas (or LPG), and solar
Residual income is what remains after required return on equity is deducted from the net income. The residual earnings model attempts to adjust the estimates of a firm’s future earnings, to account for the equity cost and place a more accurate
This enables the company to align corporate and supply strategies1. The requirement strategies base several guidelines. One base on the financial or the amount they spent and the others capitalizes on the reducing risk, use of the emergent
124-189). Nevertheless, cash flow from investment have in the year 2015 have drastically decreased as compared by the previous year 2014. Current income tax deduction emanates that share price, which is
1 pages (250 words)Essay
Got a tricky question? Receive an answer from students like you!Try us!
Let us find you another Essay on topic Discuess the statement about the pricing, valuation and sensitivities of Credit default Swaps Spreads by presenting a critical r for FREE!