This study begins with a general introduction to the credit derivatives
market and gives arguments for the growth catalysts which have driven
the development to the current state. The financial participants in this
market are presented as well. A comparison between market risk and
credit risk follows to show the clear transition that helped credit risk
to become an asset class. After that, a link to the recent Basel II
guidelines is established in order to show the policies that banks have
to consider when trading with credit risk. Chapter 2 deals with the
historical evolution of credit derivatives and classifies different
structures. A presentation of the main types of credit derivatives and
their contract elements follow; these are mainly credit default swaps
(CDS) and collaterized debt obligations (CDO). Chapter 2 also deals with
definitions of a credit event and the calculation of risk premiums.
Forms of default payment illustrate the possible settlement of a credit
derivative contract. Afterwards, an account of the International Swaps
and Derivatives Association (ISDA) is presented. This association serves
as a supplier of standardized documentation to all market participants
and facilitates transactions. Chapter 3 is the key element of this
thesis and shows the applications of credit derivatives: they serve as
portfolio diversifiers for asset managers, hedging instruments for banks
or corporations and offer arbitrage possibilities for hedge funds and
other institutions that monitor mispricings in bond and credit markets.
This part delivers essential information for the final evaluation of
such instruments from a practical point of view in Chapter 5. In Chapter
4, the thesis covers the most important pricing tools for credit
derivatives. Three generally accepted and widely used models are
presented and evaluated concerning their suitability for various
parties. These models vary greatly. Recently, a German governmental
organization has set a standard evaluation system in place; whereas
multinational investment banks form their own capacities in house or
through joint ventures. An efficient valuation system gives market
participants a major competitive advantage because they can observe
default probabilities on an ongoing basis under changing market
conditions. Chapter 5 deals with an evaluation of credit derivatives
from a practical point of view and discusses the opportunities and risks
involved in credit derivatives. The author concludes with a critical
evaluation about the role and responsibility of regulators in this
market and a view on the current situation of the global credit markets.
AUTORENVITA: Harald Seemann, Diplom-Betriebswirt (FH), 2007 Graduate in
European Business Studies at the University of Applied Sciences in
Regensburg, Germany. Currently, Mr. Seemann lives in Toronto, Canada and
works in the financial services industry.
