Bloom Berg] Credit Default Swaps

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CREDIT DEFAULT SWAPS17 October 2003Version: 1.002003 Bloomberg L.P. All rights reserved.


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BLOOMBERG

Credit Where its Due

The growth of the derivatives market continues apace. The Bank for International Settlements, thecentral banks bank, reckoned that the global derivatives market was valued at about $142 trillion atthe end of last year, based on underlying assets. The International Swaps and DerivativesAssociation (ISDA) 2002 Year-end Market Survey noted that credit derivatives were the fastestgrowing part of this market. Both ISDA and Fitch Ratings estimate that the volume of credit defaultswaps stands at about $2 trillion Fitch says that this is almost 40 percent more than it estimated inMarch. According to the British Bankers' Association (BBA), the volume of credit derivatives almostdoubled between the end of 2001 and the end of last year and is set to more than double again to$4.8 trillion by the end of 2004.

A BBA Credit Derivatives Report published on September 18, 2002, showed that more than half ofall credit derivatives transactions are booked in London, with the US accounting for less than one-

third. Banks are both the biggest buyers (52%) and the biggest sellers (39%) of protection.Securities houses are the next largest buyers of protection (21%) followed by hedge funds (12%).Insurance companies come a close second to banks as sellers of protection (33%), with securitieshouses third (16%). Most transactions provide protection for between one and five years. About two-thirds of the reference entities are A/BBB credits; nearly two-thirds are nonfinancial corporates, andabout one-fifth are banks closely followed by sovereigns.

Most credit derivatives activity is concentrated in the hands of relatively few banks JP MorganChase, Citibank and Bank of America. Federal Reserve Chairman Alan Greenspan commented onMay 8 that a single dealer seems to account for about one-third of the global market, and a handfulof dealers together seem to account for more than two-thirds.However, whilst Greenspan has saidcredit derivatives make financial markets more flexible by spreading risk, billionaire investor Warren

Buffett, the world's second-richest man, calls them financial weapons of mass destruction.The Fitch survey showed that the companies that feature most often in credit derivatives contractsare France Telecom SA, Ford Motor Co., General Motors Corp., DaimlerChrysler AG and GeneralElectricity Co. According to Bloomberg News on July 9, Matthew Cottrell, an associate director atFitch, said that a few years ago, we would have seen WorldCom Inc. and Enron Corp. at the top ofthis list. Thats something to think about.

Whatever your thoughts on credit derivatives, they constitute an important marketexperiencing explosive growth that you cannot afford to ignore. Keep on top of all the news,views, prices and analysis with the comprehensive credit derivatives functionality on theBLOOMBERG PROFESSIONAL service. Versatile. Accurate. Reliable. Give credit where itsdue

THERE HAS NEVER BEEN A BETTER TIME TO SWAP TO BLOOMBERG.

For 24 hour global customer support call +1 212 318 2000, +44 20 7330 7500, +65 6212 1000,+81 3 3201 8900 or press the HELP key twice on the BLOOMBERG PROFESSIONAL service.

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Credit Derivatives News

All the news you can use in the credit markets


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GET AHEAD WITH NEWS THAT MAKES AND BREAKS THE MARKET MOVEMENTS

Keep on top of all the latest news, views, and opinions that impact the credit derivativesmarkets. Access live TV broadcasts and breaking news stories, or catch up on archivedmulti-media reports that put the current news in perspective. BLOOMBERG NEWSstories include real-time illustrations using BLOOMBERG PROFESSIONAL functions, soyou have at your fingertips all the information you need to make your decisions. Each storyincludes not only the journalists by-line, but also their phone number and e-mail addressso you can contact them directly with your comments, opinions, and questions.

Access news, monitors, quotes and messages from your phone, Palm, or Win CE/PocketPC device so you can keep in touch with whats important for you job any time, anyplace, any how.


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Company Credit Analysis

Check a companys financial health and the extent of its obligations

ASSESS THE DANGER OF A COMPANY GOING INTO DEFAULT

View the distribution of a companys debt and loan structure, so you can anticipate anyfuture refinancing problems and decide if and when it is in danger of default.

Use sophisticated models to assess the financial health and outlook of a company, andestimate the one-year probability of default, so you can more accurately gauge the relevantcredit quality of a reference entity.


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Cash Market Spreads Bond Spreads

Investigate how the bond market values an issue relative to its peers

USE PROPRIETARY CREDIT CURVES TO ASSESS CDS SPREADS

Use the comprehensive database of par yield curves and indexes grouped by currency,industry sector, and rating so you can establish the fair value of a credit. Check the detailsof the underlying credit model the bonds used to construct the curve, the goodness of fitand the dispersion of the bonds prices about their modelled values.

Use the theoretical credit spread of a reference entity to estimate indicative CDS levels.Plot theoretical credit spreads or graph the evolution of the CDS basis.


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Cash Market Spreads Swap Spreads

Calculate how the swap market values an issue


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USE THE SWAP MARKET TO GAUGE THE CDS LEVELS

Use the Asset Swap Calculator to determine a bonds par-asset swap spread and itszspread. The z-spread is a better measure for comparing the credit quality of differentbonds and relative value with CDS than either the par-asset swap spread or theinterpolated spread over the swap curve. The credit default swap spread minus the assetswap spread is known as the CDS basis. Generally, the worse the credit of the referenceentity, the greater the basis.

Plot the history of bond spreads over swaps so you can assess if a CDS on the referenceentity may widen or tighten.


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CDS Contributor Prices

Compare CDS quotes from all the main providers including Bloomberg Generic values


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CHECK OUT DIFFERENT CDS CONTRIBUTORS BID AND ASK QUOTES

Trawl through the selection of different CDS contributors and call up their home pages. If

you find you dont have permission to see a particular providers quotes, just use thecontact details they give you on their page so you can ask them for access privileges.

Select a specific CDS for a reference entity and compare all the CDS quotes you havepermission to see on one screen so you can determine which is the best value.


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CDS Spread Curves

Set up your CDS default settings

SET UP YOUR PREFERRED SETTINGS FOR PAR CDS SPREADS CURVES, USER DEFAULTS,USER DEFINED CURVES AND CDS CONTRIBUTORS

Choose your default price sources for different currencies, market sectors, debt types, andreference entities.

Search for the CDS tickers for a particular reference entity, or look up the spread curve fora given CDS ticker.

Set up your spreads curves interpolation method, CDS ticker pricing method for missingpoints, FMC curve construction method, and CDS calculation default model.


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CDS Price Selection

Choose your price defaults for different currencies, market sectors and reference entities


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CHOOSE THE CDS SPREADS YOU WANT TO DRIVE YOUR ANALYSIS

Select up to four different price providers for a sector, group of names, or specific reference

entity. If your favorite contributor does not provide a quote for a particular CDS, your nextchoices will be selected in the order you specified. You can adjust the contributor quotes byuser-defined spreads so you can modify the shape of the curve.

The default source is the Bloomberg Generic Average Price.


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Comparative CDS Price Analysis

Check the agreement between contributors quotes and see which provides the best rate


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USE YOUR CHOSEN CDS CONTRIBUTOR WITHIN THE BLOOMBERG OR MICROSOFTEXCEL

Import the CDS prices from various sources for a group of reference entities into Excel sothat you can build your own proprietary spreadsheets.

Use the CDS quotes from different contributors simultaneously in the same function andplot the price spread history. Track historical prices from up to four providers on one graph

so you can see how they compare to each other, the market average prices, or your owncustom index.


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CDS Ca

Create, store and value your CDS deals

COMBINE THE CDS MODEL YOU PREFER WITH THE PRICE CONTRIBUTORS YOU

FIND MOST RELIABLE

Import CDS quotes from your chosen contributors or your own customized par CDS curve;input calculated credit spreads; enter cumulative default probabilities. Whichever one youhighlight, the CDS pricing model will calculate the other two.

Choose from the versatile, state-of-the-art Modified Hull-White CDS pricing model or the

widely-used JP Morgan CDS methodology (see Appendices I and II for details) to evaluatethe deal.

Mark-to-market your CDS contract, or check the market value for a given deal spread. Findout how sensitive a CDS it is to changes in credit spreads.

lculator


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FAQ Sheet

Fin

What is a Fair Market Curve and how can I use it?

A Fair Market Curve is a fixed maturity, par yield curve derived from the prices of all bonds in a

given sector. Sectors are defined by currency, industry classification, and credit rating. You canaccess the extensive database of credit curves using the function FMC. Curves are color-coded soyou can see which have been recently added or amended. The function CURV shows the bondsused to construct the curves and the tickers for the par yield curve indexes. Use the Fair MarketCurves and the FMC indexes to calculate bond spreads over swaps for generic credits so you havea guide to CDS levels.

FMC CURV

What are the differences between the asset swap spread and the z-spread?

The Asset Swap Calculator, ASW, shows a bonds asset swap spread and its z-spread. Thesespreads compare the gross price of a bond to its net present value (NPV) in the swaps market. Theasset swap spread is an annuity expressed in basis points; the NPV of this plus the gross price ofthe bond equals the NPV of the bonds cash-flows. The zspread is a constant number of basispoints added to each implied zero swap rate; the NPV of the bonds cash-flows discounted usingthis adjusted credit curve equals the bonds total price. When spreads are small, the asset swapspread and the z-spread are close. The spreads diverge for bonds from weaker credits, with the z-spread tending to be the higher. The z-spread is the better measure for estimating CDS relativevalues.

HELP ASW27

What is the CDS basis?

Calculated bond spreads are different from the reference entitys quoted CDS spreads. The CDSasis is the CDS spread minus the asset swap spread. If the CDS spread is wider than the asset

egative.You can calculate the basis using the Custom Index Expression, CIX.

CIX

Where c

Use the function MRKT to access all current market contributors quoted CDS spreads. Someproviderssee a paon their s

MRKT

d answers to frequently asked questions

bswap spread, the basis is positive; if it is tighter than the asset swap spread, the basis is n

an I see contributed CDS prices?

may give you permission to see their quotes, others will not. If you want to be enabled torticular contributors prices, contact the provider directly using the information they displaycreen.


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FAQ Sh

Find answers to frequently asked questions

How can I find the CDS tickers for a reference entity?

Call up the CDS tickers for the names on any CDS contributor page by pressing the key (this

also gives you the information you need to add the contributor page to a Launchpad view). Accessthe CDS tickers for a given reference entity from the Description Page, DES, for any of its bonds this takes you to the CDS Default screen, CDSD (see below). Search for CDS tickers or referenceentities using CDSD.

TELEFO4.5 09DES

How can I see the price quotes for a particular CDS?

For a particular CDS ticker, the All Quotes function, ALLQ, shows the price quotes from all thecontributors that have given you access to their data.

CTLFOE3ALLQ

What is the CDS Bloomberg Generic Average Price?

The Bloomberg Generic Average Price (mnemonic CBGN) is the mean of all contributor prices thathave updated during the day, excluding the highest and lowest prices when there are 5 or morecontributed prices that day for that ticker; (a generic is posted only if at least 2 prices arecontributed). The CBGN is the same for all customers, irrespective of which contributors they canaccess.

Can I choose what CDS prices to use?

Yes. Use CDSD to select your favorite CDS spread contributors for a particular currency, marketsector, debt type or individual issuer; combine contributed quotes with user-defined spreads; choosewhich method to use for spread curve interpolation, and what values to use for missing points. Youcan also append a specific CDS pricing contributors mnemonic to the CDS ticker if you want to usetheir spreads either within the environment of the BLOOMBERG PROFESSIONAL service orwithin a spreadsheet. This lets you compare and graph the prices from different sources includingthe Bloomberg Generic Average Price using the mnemonic CBGN.

CDSD CTLFOE5 CBGN

Can I store and mark-to-market my CDS trades?

Yes. Use the CDS pricing calculator, CDSW, to create and store your CDS deals. Select whichpricing model you want to use the JP Morgan model or the Modified Hull-White model (SeeAppendices I and II) and choose the price source you prefer (see above).

CTLFOE3CDSW

eet continued


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Appendix I

The JP Morgan Credit Default Swap Model


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Appendix II

The Modified Hull-White Credit Default Swap Model


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Appendix II continued

The Mod

ified Hull-White Credit Default Swap Model


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Documents

Bloom Berg] Credit Default Swaps