CH Capital CDS Market
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Transcript of CH Capital CDS Market
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7/31/2019 CH Capital CDS Market
1/23
CHCapitalPartnersLLC
CreditDefaultSwap
Howitworks
By
SokH.CordellSr.ManagingDirector
Knowwhoyouareworkingwith
ContinuallyStrivingtoEducatethePublicTocreatejobsforourFellowAmericans
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7/31/2019 CH Capital CDS Market
2/23
CreditDefaultSwaps
ACredit
Default
Swap
(CDS)
is
acontract
in
which
the
writer
offers
the
buyer
protectionagainstacrediteventinareferencenameforaspecifiedperiodof
timeinreturnforapremiumpayment.
TypicalCDScashflows
Thecontract
pays
par
in
return
for
100
nominal
of
debt
if
the
reference
name
suffersacrediteventbeforethematurityofthedeal.
Thebuyerpaysapremiumquarterlyinarrears.
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CDSStructure
Protection
BuyerProtection
Seller
Quarterlypremium
inarrears
Protection
Buyer
Protection
Seller
Defaulteddebtof
referencename
Parless
fractionof
premium
Predefault
Postdefault
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StochasticLoanPricingModelFinancialEngineering
-$17.28 $15.69
5.0%4.2%
90.0%90.0%
5.0%5.8%
0.000
0.005
0.010
0.015
0.020
0.025
0.030
0.035
0.040
0.045
-$
30
-$
25
-$
20
-$
15
-$
10
-$
5
$
0
$
5
$
10
$
15
$
20
$
25
Loan $ AmountComparison with Normal(0,10)
LoanAmount Normal(0,10) Log.(Normal(0,10))
DelX DelY
17.28253 0.045
15.69024 0.045
23.64127 0.045
0.796149 0.045
20.34512 0.045
X1 Y1
25.18757 0.004103
22.75059 0.004103
20.31361 0.008207
17.87663 0.008207
15.43965 0.016414
13.00266 0.016414
10.56568 0.028724
8.128702 0.028724
5.69172 0.036931
3.254739 0.041034
0.817758 0.036931
1.619223 0.041034
4.056204 0.032828
6.493185 0.028724
8.930167 0.024621
11.36715 0.020517
13.80413 0.01231
16.24111 0.008207
18.67809 0.004103
21.11507 0.008207
23.55205 0
X2 Y2
30 0.000443
29.88978 0.000458
29.77956 0.000473
29.66934 0.000489
29.55912 0.000505
29.4489 0.000522
29.33868 0.000539
29.22846 0.000557
29.11824 0.000575
29.00802 0.000594
28.8978 0.000613
28.78758 0.000633
28.67735 0.000653
28.56713 0.000674
28.45691 0.000696
28.34669 0.000718
28.23647 0.000741
28.12625 0.000764
28.01603 0.000788
27.90581 0.000813
27.79559 0.000838
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StochasticLoanPricingModelFinancialEngineering
-$17.28 $15.94
5.0%4.2%
90.0%90.2%
5.0%5.6%
0.000
0.005
0.010
0.015
0.020
0.025
0.030
0.035
0.040
0.045
-$
30
-$
20
-$
10
$
0
$
10
$
20
$
30
$
40
Net IncomeComparison with Normal(0,10)
NetIncome Normal(0,10)
Del X Del Y
-17.2795 0.045
15.936 0.045
-23.6397 0.045
-0.67174 0.045
27.968 0.045
X1 Y1
29.75648 0.003142
26.57389 0
23.3913 0.003142
20.20872 0.009426
17.02613 0.009426
13.84355 0.018853
10.66096 0.028279
7.478374 0.034563
4.295788 0.034563
1.113201 0.040847
2.069385 0.037705
5.251971 0.031421
8.434557 0.021995
11.61714 0.018853
14.79973 0.009426
17.98232 0.006284
21.1649 0.003142
24.34749 027.53007 0
30.71266 0.003142
33.89525 0
X2 Y2
30 0.000443
29.85972 0.000462
29.71944 0.000482
29.57916 0.000502
29.43888 0.000524
29.2986 0.000546
29.15832 0.000568
29.01804 0.000592
28.87776 0.000617
28.73747 0.000642
28.59719 0.000668
28.45691 0.000696
28.31663 0.000724
28.17635 0.000753
28.03607 0.000784
27.89579 0.000815
27.75551 0.000847
27.61523 0.000881
27.47495 0.000916
27.33467 0.000952
27.19439 0.000989
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CreditDefaultSwaps
LenderPurchasesCDSfromaCounter
Partyforcost
Premiumsfromthelenderispaidaspart
ofthecostofInsurance
FinancialModelsarecreatedto
determinethecostandpriceofthe
insurance
TheCDSsaretradedonadailywith
Bloombergorotheritemstopriceonthe
dailytrade
ThesearetheinstrumentsthatbasicallybroughttheUSeconomy
down
LikeaStock,theseinstrumentsarepriced
everyminute
TheproblemsareveryfewpeoplewithMathand
EngineeringDegrees
understandthecomplexityoftheseinstruments
Inanefficientmarketwithhighlypaidcompetent
professionals,it humanscannotmakedecisionsontheseengineeringmodels
quickenough
Thatisthereasonforthedisclosurescanbeaslongas
2,000pageswithlegaljargonthatisoftenhardto
understand
CDSisverycomplexwith
FinancialEngineering
Models
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CashFlowfromCDS
Likeindividuals
pay
for
Mortgage
Insurance
or
Auto
Insurance,
the
CDSs
have
premiums
in
which
theinsuredisbuyingonamonthlyorquarterlypayments.
ThesepaymentsissubtractedfromtheriskandcalculatedwiththefutureprofitthroughNPV
Modelswhichhelpthetradersunderstandwhatheorsheisbettingontheotherside.
CDSsaresocomplex,sometimesthetradersdonotevenunderstandwhichsideheorsheis
betting
Theseinstrumentscreatecashflowfortheinsurerandtheinsuredpaysthatcashflow.
Whatstartedouttobeasimplemarket,hasturnedintoacalculatedbetonWallStreet.
Itisnolongerbenefittingtheeconomy,butactuallybenefittingfewfirmswhocanhirethebest
peoplewhofullyunderstandtheCreditDefaultSwapMarkets,theseEngineerscreatemodelsare
socomplicated,
depending
on
who
created
the
model,
most
in
the
market
place
and
risk
managers
cannotfullycomprehendthesophisticatedriskitimposestotheeconomy.
CreditDefault
Swaps
PremiumsPaidMonthlyInsuredCreatesSecuritiesfortheseinstruments
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Time Hazard Default Survival
(years) Rate Probability Probability
0 1
1 0.02 0.02 0.98
2 0.02 0.0196 0.9604
3 0.02 0.019208 0.941192
4 0.02 0.01882384 0.92236816
5 0.02 0.018447363 0.903920797
Nowweconsidera5YearCDSonthisReferenceEntity.
AdditionalAssumptions:
RecoveryRate 0.4
SwapPayments
LIBOR 0.05
NotionalPrincipal 1
CDSSpread 0.012424885
1
0.012176387
0.951229425
0.011582538
0
0.2
0.4
0.6
0.8
1
1.2
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5
PremiumsReceived
PremiumPricing
CDSPremiumPricing
Year1
Year2
Year3
Year4
Year5
PremiumPricingModelforCDS
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CDSExample
ProtectionBuyer
Protection
Seller
314.486bps
quarterlyinarrears
Protection
Buyer
Protection
Seller
$1,000,000
plusfractionof
premium
Predefault
Postdefault
$1,000,000Par
GMAC
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ParAssetSwapExample
InterestRate
SwapDesk
Trading
DeskInvestor
Floating Floatingpayments
+paratmaturity
ParFixed
Credit
Market
CashBondDirtyPriceFixedCoupon
CreditBond
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CDS AssetSwapHedge
InterestRate
SwapDeskTrading
Desk
Investor/
Protection
Buyer
Floating Floatingpayments
+paratmaturity
ParFixed
Credit
Market
CashBondDirtyPriceFixedCoupon
CreditBond
Protection
Seller
Quarterlypremium
inarrearsand
defaulted
debt
upon
default
Parless
fractionof
premiumupon
default
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AssetsSwap
SampleFacilityInformation
BorrowerHospitalityofWashington
Lenders:CMBSConduitLender
Amount:$11,000,00010yearNonRecourse
Purpose:ConstructiontoPermanentLoan
Lender'sROAGuideline:1.15%
FacilityInformationEnterUnsecured LineofCredit(AssumedToBeFullyUtilized) 11,000,000
Enter12MonthAverageBalances(AssumeBalancesNotFree) 657,000
EnterBaseRate(PrimeorLIBOR) 10.5%
EnterSpreadOverBase 1.75%
Enter %FacilityFees(NotConnectedToBalances!) 2.00%
EnterFundingCostsofWACC 2.65%
EnterServicing:Enter%orCompleteScheduleTwo 1.70%
EnterLoan
Loss
Expense
(Applied
To
Income
Statement) 1.50%
Enter%EquityReserveRequirement(FunctionofUnexpectedRisk) 25.00%
EnterTaxes 35%
DepositInformation12monthaveragebalances 657,000
EnterActivityCostsasaPercentofBalances 4.09%
EnterBalanceRequirement 8.75%
NetBorrowedFunds 10,343,000
InterestRate:Prime+1.5% 12.21%
FeesinlieuofBalances 7,673
ReturnonAssetsCalculation
LoanAmount 11,000,000
NetIncome 601,288
ReturnonAssets 5.466%
ReturnonRiskAdjustedCapitalCalculation
%EquityReserve Requirement(FunctionofUnexpectedRisk) 25.00%
LoanAmount 11,000,000
$AmtEquityReserve Allocation(FunctionofUnexpectedRisk) 2,750,000
NetIncome 601,288
RAROC 21.87%
Summary:BaseCase
BorrowerPicnicFurnitureManufacturingCo
Lenders:SecondCityBank
LoanRevenue
1,570,55
9
Facility
11,000,0
00
Net
Income 601,288
ROA 5.466%
FacilityROAHurtleRate 1.15%
FacilityInternalRateofReturn(SeeBradyWorksheet)
OptionPricingGeneratedHurtleRate(OptionPr
Worksheet)
RAROC 21.87%
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AssetSwapCalculator
Base Value:0.0139484609812889 Input Changes
Precedent Cell
Output
Downsi
de
Output
Upside
Effectiv
e
Range
Input
Downsi
de
Input
Upside
Base
Case
Value
Base Rate (Prime or
LIBOR) 0.72% 2.07% 1.36% 9.4% 11.5% 10.5%
Funding Costs 1.94% 0.85% 1.10% 7.59% 9.27% 8.43%
Servicing 1.57% 1.22% 0.35% 2.43% 2.97% 2.70%
% Facility Fees 1.26% 1.52% 0.26% 1.80% 2.20% 2.00%Spread Over Base 1.28% 1.51% 0.23% 1.58% 1.93% 1.75%
Loan Loss Expense 1.49% 1.30% 0.20% 1.35% 1.65% 1.50%
Enter Taxes 1.47% 1.32% 0.15% 32% 39% 35%
Balance
Requirement 1.34% 1.44% 0.10% 9.00%11.00% 10.00%
Facility Amount 1.34% 1.44% 0.10%
900,00
0
1,100,0
00
1,000,0
00
Cost of Funds 1.34% 1.44% 0.10% 7.43% 9.08% 8.25%
Unsecured Line of
Credit 1.44% 1.36% 0.07%
900,00
0
1,100,0
00
1,000,0
00
Annual Activity
Costs 1.41% 1.38% 0.03% (1,800) (2,200) (2,000)
Reserve % Facility 1.40% 1.39% 0.01% 6.30% 7.70% 7.00%
Allocated Variable 1.39% 1.39% 0.00% 0 0 0
Direct fixed 1.39% 1.39% 0.00% 0 0 0
Cost of Funds 1.39% 1.39% 0.00% 7.43% 9.08% 8.25%
Direct Variable 1.39% 1.39% 0.00% 0 0 0
Balance
Requirement 1.39% 1.39% 0.00% 9.00%11.00% 10.00%
Loan Loss Reserve
% Facility 1.39% 1.39% 0.00% 6.30% 7.70% 7.00%
Allocated fixed 1.39% 1.39% 0.00% 0 0 0
LIBOR (Prime) Rate 1.39% 1.39% 0.00% 9.45%11.55% 10.50%
Facility Amount 1.39% 1.39% 0.00%
900,00
0
1,100,0
00
1,000,0
00
1.39%
1.39%
0.00%
9.45%
11.55%
10.50%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
0.00% 10.00%20.00%30.00%40.00%50.00%
OutputDownside
OutputUpside
EffectiveRange
InputDownside
InputUpside
BaseCaseValue
CDSPriceModel
LIBOR(Prime)Rate
Allocatedfixed
BalanceRequirement
CostofFunds
Reserve%Facility
CostofFunds
FacilityAmount
BalanceRequirement
EnterTaxes
SpreadOverBase
%FacilityFees
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SwapModelPricing
Time Recovery Expected Discount PVof
(years) Rate Payoff Factor* ExpectedPayoff
0.5 0.4 0.012 0.975309912 0.011703719
1.5 0.4 0.01176 0.927743486 0.010910263
2.5 0.4 0.0115248 0.882496903 0.0101706
3.5 0.4 0.011294304 0.839457021 0.009481083
4.5 0.4 0.011068418 0.798516219 0.008838311
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
1 2 3 4
Premium
Pay
Off
Years
CDSPremiumPayoff
4.5
3.5
2.5
1.5
0.5
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CDS AssetSwapHedgeExample
InterestRate
SwapDesk
Market
Makers
Protection
Buyer
Credit
Market
Protection
Seller
$10,000,000Par
MortgagePool55/8s
of5/15/2020
Floating3M
LIBOR+273.7bps
$10,000,000
initially
Fixed
5.45232%
semi
annual
Floating3M
LIBOR+256.8bps
314.486bps
quarterlyinarrears
$10,000,000
lesspartial
premiumon
defaultevent
$10,000,000
parof
Mortgage
Tranchedebt
ondefault
event
$9,300,000+$42,187.50=$9,342,187.50
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InitialCashflows
InterestRate
SwapDeskMarket
Makers
Protection
Buyer
Credit
Market
Protection
Seller
$10,000,000Par
MortgagePool55/8s
of5/15/2020
$9,300,000+$42,187.50=$9,342,187.50
$10,000,000
initially
$719,881
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TypicalPeriodicCashflows
InterestRate
SwapDesk
Market
Makers
Investor/
Protection
Buyer
Market
Protection
Seller
$281,250
semiannually
LIBOR+$68,425
quarterly
(approx.
$204,200)
$272,616semi
annually
LIBOR+$64,200
quarterly
(approx.
$200,000)
$79,495quarterly
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CashflowsonDefault
InterestRate
SwapDesk
Market
Makers
Protection
Buyer
Credit
Market
Protection
Seller
$10,000,000Par
defaulted
MortgagePool 55/8s
of5/15/2009
$10,000,000
lesspartial
premium
UnwindIRswapUnwindIRswap
$10,000,000Par
defaulted
MortgagePool55/8s
of5/15/2009orsimilar
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IstheProtectionBuyerHedged?
Upondefault,theprotectionbuyerreceives$10mfromtheprotectionseller
and(assuming40%recovery)deliversdefaulteddebtworth$4m.Atthe
inceptionof
the
contract,
the
Mortgage
Pool
note
was
only
worth
$9.3m.
So
thebuyerreceivesanetof$6mfromtheCDS,hasreallylostonly9.34=$5.3m.
SothebuyerhastoomuchCDS.Thecorrecthedgeratioisgivenby
Inthiscasetheprotectionbuyershouldbuy$10mx(.93.4)/(1.4)=$8.9m
notionalCDStobehedged.
( )
(1 )
bond price R
CDS notional bond notional R
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CDSBasis
Anumber
of
factors
observed
in
the
market
serve
to
make
the
price
of
credit
risk
that
hasbeenestablishedsyntheticallyusingcreditdefaultswapstodifferfromitspriceas
tradedinthecashmarketusingassetswaps.
Identifyingsuchdifferencesgivesrisetoarbitrageopportunitiesthatmaybeexploited
bybasistradinginthecashandderivativemarkets.Thisinknownastradingthecredit
defaultbasis
and
involves
either
buying
the
cash
bond
and
buying
aCDS
on
this
bond,
orsellingthecashbondandsellingaCDSonthebond.
Thedifferencebetweenthesyntheticcreditriskpremiumandthecashmarket
premiumisknownasthebasis.
CDSPremium
Z
Spread
=basis.
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CDSBasis
Basis=314.486291.9=22.586
InterestRate
SwapDeskMarket
Makers
Protection
Buyer
Credit
Market
Protection
Seller
$930,000+$4,218.75=$934,218.75
Floating3M
LIBOR+273.7bps
$1,000,000Fixed
5.45232%
semiannual
Floating3M
LIBOR+256.8bps
314.486bps
quarterlyin
arrears
$10,000,000Par
GMAC55/8s
of5/15/2009
ZSpread=291.9
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CDSBasis
Thebasis
is
usually
positive,
occasionally
negative,
and
arises
from
a
combinationofseveralfactors,including
Bondidentity:Thebondholderisawareoftheexactissuethattheyareholdingin
theeventofdefault;however,defaultswapsellersmayreceivepotentiallyany
bond
from
a
basket
of
deliverable
instruments
that
rank
paripassu with
the
cash
asset.Thisisthedeliveryoptionheldbytheprotectionbuyer.
Dependingontheprecisereferencecredit,theCDSmaybemoreliquidthanthe
cashbond,resultinginalowerCDSprice,orlessliquidthanthebond,resultingina
higherprice.
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Disclosure
Theseslides
are
for
educational
purpose
only,
CH
Capital
Partners
LLC
amember
of
CFG
is
not
liable
for
any
information
pertaining
the
subject
matter.
Thesematerialsareforeducationalonly.CHCapitalPartnersLLC isregisteringtobeaRIAfirmtospecializeincreatingSBA FMLPLoanFundsforinvestors,
CHCapitalPartnersLLChasextensivebackgroundinbondfinancingtostructureandcreatingloansandpackagingthroughallpartsoftheprocess.