TAILIEUCHUNG - Credit Swap Valuation Darrell Duffie

Credit events may be defined in terms of downgrades, events that could instigate the default of one or more counterparties, or other credit-related Swaps involve some risk of disagreement about whether the event has, in fact, occurred, but in this discussion of valuing the credit swap, such risk of documentation or enforceability will be ignored. In the event of termination at the designated credit event, Party A pays Party B a stipulated termination amount. For example, in the most common form of credit swap, called a “default swap,” if the termination is triggered by the default of Entity C, A pays B an amount that is, in effect, the difference between the face. | Credit Swap Valuation Darrell Duffie This review of the pricing of credit swaps a form of derivative security that can be viewed as default insurance on loans or bonds begins with a description of the credit swap contract turns to pricing by reference to spreads over the risk-free rate of par floating-rate bonds of the same quality and then considers model-based pricing. The role of asset swap spreads as a reference for pricing credit swaps is also considered. Credit swaps pay the buyer of protection a given contingent amount at the time of a given credit event such as a default. The contingent amount is often the difference between the face value of a bond and its market value and is paid at the time the underlying bond defaults. The buyer of protection pays an annuity premium until the time of the credit event or the maturity date of the credit swap whichever is first. The credit event must be documented with a notice supported with evidence of public announcement of the event in for example the international press. The amount to be paid at the time of the credit event is determined by one or more third parties and based on physical or cash settlement as indicated in the confirmation form of the OTC credit swap transaction a standard contract form with indicated alternatives. The term swap applies to credit swaps because they can be viewed under certain ideal conditions to be explained in this article as a swap of a default-free floating-rate note for a defaultable floating-rate note. Credit swaps are currently perhaps the most popular of credit Unlike many other derivative forms in a credit swap payment to the buyer of protection is triggered by a contractually defined event that must be documented. The Basics The basic credit swap contract is as follows. Parties A and B enter into a contract terminating at the time of a given credit event or at a stated maturity whichever is first. A commonly stipulated credit event is default by a named issuer .

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