credit
信用证样本-学习信用证
首先是信用证审核，信用证审证的基础是以前的谈判结果或合同，并应坚持由知名大银行开立或保兑、单证及其他要求合理可行（备单做事不求人）、无“软条款”（可参考《福步外贸论坛资料整理大全》信用证软条款：出口商的陷阱、实践中常见的软条款）前后一致的原则。合同谈判及信用证审核的结果必须便于执行信用证时的备货储运和备单，便于备货储运指能够在信用证规定的期限内完成规定的生产包装和报关装运事宜；便于备单既指能够按时备齐相关单证以便在信用证规定的期限内完成备货储运，更重要的是指能够备齐单证尤其是其他机构出具的单证以便及时结汇。合同谈判和审证是为了解决不能办到或不能按时办到，甚至模棱两可的事，在此基础上备单审单要树立“信用证至高无上”的原则，做到严格按照信用证备好单证、审好单证，以便结汇，尤其是其他机构出具的单证，务必事先核对好，并书面确认，避免人为疏忽造成不符点）（备单审单原则：单证相符（以信用证为基础对规定的各项单据进行一一审核，要求有关单据严格按照信用证的规定）、单单相符（以商业#5@p为中心审核其他单据，使有关内容相互一致）
信用证样本
Issue of a Documentary Credit （开证行,一般为出口商的往来银行，须示开证行的信用程度决定是否需要其他银行保兑confirmation 见49）
BKCHCNBJA08E SESSION: 000 ISN: 000000 BANK OF CHINA LIAONING NO. 5 ZHONGSHAN SQUARE ZHONGSHAN DISTRICT DALIAN CHINA
Destination Bank （通知行 advising bank 见57A）
KOEXKRSEXXX MESSAGE TYPE: 700 KOREA EXCHANGE BANK SEOUL 178.2 KA, ULCHI RO, CHUNG-KO （一般由受益人指定往来银行为通知行，如愿意通知，其须谨慎鉴别信用证表面真实性；应注意信用证文本的生效形式和内容是否完整，如需小心信用证简电或预先通知和由开证人直接寄送的信用证或信用证申请书，因其还未生效，且信用证一般通过指定通知行来通知，可参考《出口实务操作》page237）
40A Type of Documentary Credit （跟单信用证类型）
IRREVOCABLE （信用证性质为不可撤消。在信用证中需明示其是可撤或不可撤，如无明示，信用证应视为不可撤；只有明确“可装让”的信用证方可装让）
20 Letter of Credit Number （信用证号码）
LC84E0081/99 （信用证号码,一般做单时都要求注此号）
31G Date of Issue （开证日期）
990916
31D Date and Place of Expiry （信用证到期时间地点。通常最后装船期的时间加上单据提示的时间就是信用证到期时间。通常要求在出口商国内到期。审证时也应注意信用证是否有有条件生效条款，如“待获取进口许可证时才生效”）
991015 KOREA
51D Applicant Bank （开证行）
BANK OF CHINA LIAONING BRANCH
50 Applicant （开证申请人）
DALIAN WEIDA TRADING CO., LTD
59 Beneficiary （受益人）
SANGYONG CORPORATION CPO BOX 110 SEOUL KOREA （名称与地址与印就好的文件上的要一致，其他单据制作照抄此名址即可）
32B Currency Code, Amount （信用证结算货币和金额）
USD 1,146,725.04 （与此相关的可参考《全新出口单证操作与技巧》page79-82）
41D Available with...by... （指定的有关银行和信用证兑付方式）
ANY BANK BY NEGOTIATIO （意为任何银行议付，有的信用证为 ANY BANK BY PAYMENT,此为银行付款后无追索权； 前则有追索权，就是有权限要回已付给你的钱，其实为贴现行、购票行，为善意第三人 。通常要求在出口商国内交单，即交单行为国内银行）
42C Drafts at （汇票付款期限）
45 DAYS AFTER SIGHT （见证45天内付款）
42D Drawee （汇票付款人受票人）
BANK OF CHINA LIAONING BRANCH （亦称受票行 drawee bank ，通常也是付款行paying bank，付款人不能为信用证申请人）
43P Partial Shipments （分装条款）
NOT ALLOWED （此为分装不允许。UCP500除非信用证明确不准分批装运，卖方即有权分批装运）
43T Transhipment （转运条款）
NOT ALLOWED （此为转船不允许。UCP500如在信用证中没有是否允许转运的表述，则视为允许转运。对允许转运的货物，一般不宜接受“卖方指定中途港”或“卖方指定二程船公司或船名”等条件。如禁止转运，只要提单证明货物是装在集装箱、拖车或子母船上的，即使提单注明将有转船，也不做不符，但须由同一份提单包括整个航程）
44A Shipping on Board/Dispatch/Packing in Charge at/ from （装船、发送和货物接收监管的地点）
RUSSIAN SEA （起运港）
44B Transportation to （货物发送的最终地）
DALIAN PORT, P.R.CHINA （目的港）
44C Latest Date of Shipment （最迟装运期）
990913 （44C在CIF时使用，FOB使用44D SHIPMENT PERIOD。装期应便于合理备货及制作和申领相关单证，如生产包装、船期安排、内陆运输、制作商业#5@p装箱单、报检取商检证申领产地证许可证核销单及其他认证签证、投保取单、整理审理单证、报关查关及其他以外事故）
45A Description of Goods or Services （货物描述）
FROZEN YELLOWFIN SOLE WHOLE ROUND (WITH WHITE BELLY) USD770/MT CFR DALIAN QUANTITY: 200MT ALASKA PLAICE (WITH YELLOW BELLY) USD600/MT CFR DALIAN QUANTITY: 300MT （关于货物描述可参考《全新出口单证操作与技巧》page76（2））
46A Documents Required: （单据要求） （单证及其他要求合理可行：备单不求人，应拒绝由客人或其授权人出具并证实的单证文件，如客检证，也要谨慎考虑由其他机构出具的单据文件证明认证能否办理或能否及时办理，所需份数尤其是正本份数能否如数提供，可参考UCP500第二十三条b、c、d；单证出具日期是否符合逻辑性和国际惯例，可参考《外贸七日通》page73；单据填制是否合理，如要求出具记名提单等） （备单审单原则：单证相符、单征相符）
1. SIGNED COMMERCIAL INVOICE IN 5 COPIES. （签字的商业#5@p五份 ） （关于货物描述可参考《全新出口单证操作与技巧》page76（2））
2. FULL SET OF CLEAN ON BOARD OCEAN BILLS OF LADING MADE OUT TO ORDER AND BLANK ENDORSED, MARKED "FREIGHT PREPAID" NOTIFYING LIAONING OCEAN FISHING CO., LTD. TEL 86)411-3680288 （一整套清洁已装船提单, 抬头为TO ORDER 的空白背书,且注明运费已付,通知人为LIAONING OCEAN FISHING CO., LTD. TEL 86)411-3680288 ） （应谨慎处理正本提单直接寄送客人的条款）
3. PACKING LIST/WEIGHT MEMO IN 4 COPIES INDICATING QUANTITY/GROSS AND NET WEIGHTS OF EACH PACKAGE AND PACKING CONDITIONSAS CALLED FOR BY THE L/C. （装箱单/重量单四份, 显示每个包装产品的数量/毛净重和信用证要求的包装情况.）
4. CERTIFICATE OF QUALITY IN 3 COPIES ISSUED BY PUBLIC RECOGNIZED SURVEYOR. （由PUBLIC RECOGNIZED SURVEYOR签发的质量证明三份.）.
5. BENEFICIARY'S CERTIFIED COPY OF FAX DISPATCHED TO THE ACCOUNTEE WITH 3 DAYS AFTER SHIPMENT ADVISING NAME OF VESSEL, DATE, QUANTITY, WEIGHT, VALUE OF SHIPMENT, L/C NUMBER AND CONTRACT NUMBER. （受益人证明的传真件, 在船开后三天内已将船名航次,日期,货物的数量, 重量价值,信用证号和合同号通知付款人. ）
6. CERTIFICATE OF ORIGIN IN 3 COPIES ISSUED BY AUTHORIZED INSTITUTION. （当局签发的原产地证明三份）.
7. CERTIFICATE OF HEALTH IN 3 COPIES ISSUED BY AUTHORIZED INSTITUTION. （当局签发的健康/检疫证明三份）.
47A ADDITIONAL INSTRUCTIONS （附加指示）
1. CHARTER PARTY B/L AND THIRD PARTY DOCUMENTS ARE ACCEPTABLE. （租船提单和第三方单据可以接受）
2. SHIPMENT PRIOR TO L/C ISSUING DATE IS ACCEPTABLE. （装船期在信用证有效期内可接受
这句是不是有点问题?先于L/C签发日的船期是可接受的. 对否? ）
3. BOTH QUANTITY AND AMOUNT 10 PERCENT MORE OR LESS ARE ALLOWED. （ 允许数量和金额公差在10%左右 ） （与此相关的可参考《全新出口单证操作与技巧》page76-79）
71B Charges （费用）
ALL BANKING CHARGES OUTSIDE THE OPENNING BANK ARE FOR BENEFICIARY'S ACCOUNT.
（公平原则是分摊 参见《外贸七日通》page103-8）
48 Period for Presentation （单据提示日期）
DOCUMENTSMUST BE PRESENTED WITHIN 15 DAYS AFTER THE DATE OF ISSUANCE OF THE TRANSPORT DOCUMENTS BUT WITHIN THE VALIDITY OF THE CREDIT. （一般表明在提单出具后若干天，且在到期日内。通常最后装船期的时间加上单据提示的时间就是信用证到期时间，交单日必须便于合理制单结汇，一般如领取提单、签发汇票、
制作受益人证明、整理审理单证、银行退回更正及其他体外事故等，且在有效期内。信用证有规定的，按规定交单，若信用证没有规定交单期，向银行交单的日期不得晚于提单日后21天，在有效期内）
49 Confimation Instructions （保兑指示）
WITHOUT （须示开证行的信用程度决定是否需要其他银行保兑）
78 Instructions to the Paying/Accepting/Negotiating Bank: （对付款行、议付行、承兑行的指示）
1. ALL DOCUMENTS TO BE FORWARDED IN ONE COVER, UNLESS OTHERWISE STATED ABOVE.
2. DISCREPANT DOCUMENT FEE OF USD 50.00 OR EQUAL CURRENCY WILL BE DEDUCTED FROM DRAWING IF DOCUMENTS WITH DISCREPANCIES ARE ACCEPTED.
57A "Advising Through" Bank （通知行）
KOEXKRSEXXX MESSAGE TYPE: 700 KOREA EXCHANGE BANK SOUTH KOREA 178.2 KA, ULCHI RO, CHUNG-KO
第二篇：Credit_risk
Thecurrentissueandfulltextarchiveofthisjournalisavailableat
/0307-4358.htm
Creditriskmanagement
Theuseofcreditderivativesbynon-financialcorporations
MarkC.Freeman
BradfordUniversitySchoolofManagement,Bradford,UK,andUseofcreditderivatives761
PaulR.CoxandBrianWright
SchoolofBusinessandEconomics,UniversityofExeter,
Exeter,UK
Abstract
Purpose–Thispaperaimstoexplorethepossibleuseofcreditderivativesbycorporatetreasurers.Corporationshave,inrecentyears,growncomfortablewiththeideaofusingtraditionalderivativeproductstohedgetheirexposureto,forexample,interestrateandforeignexchangerisk.Creditrisk,ontheotherhand,hasprovenamoredifficultanimaltotame.Whilstavenuesforthemanagementofcreditriskdoexist,forexample,bytheuseoftraditionalinsuranceproductsandlettersofcredit,suchmeansarenotalwaysconvenient.
Design/methodology/approach–Inthispaper,boththeacademicandpractitionerliteratureoncreditderivativesandtheirapplicationarereviewed.Then,bymeansofsomesimplenumericalexamples,thepossibleusestowhichcorporatetreasurersmightputcreditdefaultswapsandtotalreturnswapsareillustrated.
Findings–Thecreditderivativesmarketis,atpresent,dominatedbylargebanksandinsurancecompanieswhotradecreditexposureamongthemselves.Asthecreditderivativesmarketbecomesmoreliquidandtransparent,itisasked:‘‘Shouldcorporatetreasurersconsiderusingcreditderivativestomanagetheircreditriskexposure?’’Anumberofsimpleandpracticalwaysinwhichcorporationscanusecreditderivativestomanageriskareexploredandthepracticalstrengthsandweaknessesoffollowingsuchapproachesareemphasised.
Originality/value–Thispaperisofparticularvaluetocorporatetreasurers.Thisisoneofthefirstacademicpaperstoconsidercreditderivativesfromafinancialmanagementperspective.KeywordsRiskmanagement,Credit,Organizations,Derivativemarkets
PapertypeViewpointpaper
1.Introduction
Corporatetreasurershaveinrecentyearsgrownaccustomedtomanagingvariousdimensionsoftheirfirms’riskprofiles.Theuseofderivativestohedgeinterestrateandforeignexchangeexposurehasbecomeacommonplace.Indeed,formulti-nationalfirms,themanagingofsuchexposureisastandardpartoftheirtreasuryfunction[1].Oneaspectoffinancialriskthathasprovendifficulttohedge,however,hasbeenthatofthecreditriskfacingfirms.Thisrisktakesseveralobviousforms.Forexample,anon-financialcorporationholdingalargeportfolioofthebondsofitscustomersand/orsuppliersisclearlyexposedtocreditrisk,asisafirmwhenitsuppliestoacustomeronstandardtradecreditterms.Creditriskalsotakesseverallessobviousforms.Forexample,afirmthathasissuedexchangeablebondsthatareconvertibleintoathirdparty’ssharesinwhichtheissuingfirmisasubstantialexistingshareholder,orthepoolingoffinancialresourcesandrisksthatarisesinjointventures,alliancesandfirm-to-firminvestments.Financialandindustrialcorporationshaveeveryincentivetoimprovetheirmodellingandtradingofcreditrisk.Theexplosivegrowthofthecreditderivativesmarkethasdistributedcreditriskthroughthefinancialsystem,packagedinnewforms.Anexpandingcreditriskmarketraisesinterestingpossibilitiesforcorporatetreasurerswishingtominimiseexposuretocredit
risk.ManagerialFinanceVol.32No.9,2006pp.761-773#EmeraldGroupPublishingLimited
0307-4358
DOI10.1108/03074350610681952
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32,9
762Thispaperexaminestherapidlydevelopingmarketforcreditderivativesandattemptstoanswer,throughaseriesofsimpleexamples,thequestionofwhethercorporatetreasurersshouldaddcreditderivativestotheirexistingarmouryofriskmanagementtechniques.Thecreditderivativesmarketisrapidlydeveloping.Takingcreditderivativesofalltypes,about$5,000billionindebtwillhavebeenprotectedagainstdefaultduring2004.Whilsttherangeofavailableinstrumentsandtheirapplicationcontinuestoincrease,
themarketstilllacks,atthetimeofwriting,thetransparencyandliquidityofmoretraditional,exchange-tradedinstruments.However,anumberofinstitutionalattemptstostandardisethemarket,forexample,bytheInternationalSwapsandDerivativesAssociation(ISDA)andtheemergenceofactivecreditderivativeindicessuchasiBoxx,conceivedbyaconsortiumofbanks,andTrac-X,launchedbyMorganStanleyandJPMorgan(nowmanagedbyDowJones),arebeginningtofashionthecreditderivativesmarketintoamoregenerallyusefulform.Noattemptismadeheretoconsideralloftheavailableinstrumentsandapplicationsofcreditderivativesforthecorporateuser.Rather,weillustratethepotentialusefulnessoftheseinstrumentsbyfocusinginontwoparticularkindsofinstrument:thecreditdefaultswapandthetotalreturnswap.
Theremainderofthepaperisstructuredasfollows.Section2introducesthecreditderivativesmarketsandconsidersbrieflythemaincontractsavailableintheover-the-countermarket.Section3looksattheimpactofthecreditderivativesmarketonnon-financialcorporations.InSection4,weconsidertheuseofcreditderivativesbycorporateriskmanagerstomanagetheirexternalcreditriskexposure.Thisisfollowedup,inSection5,withaconsiderationofwhethermanagersshouldtradeincreditderivativeswrittenagainsttheirowncompanies.Theymay,forexample,wishtopurchasecreditprotectiontohedgeagainstreceiptsfromfuturebondissuesorsellcreditprotectiontoexploitinformationalasymmetry.Section6presentssummaryandconclusions.
2.Marketforcreditderivatives
Themarketforcreditderivativeshasbeen,andstillis,dominatedbybanksandinsurancecompanies,whotradecreditriskamongthemselveswithincentivestodistributeanddiversifyrisk,gainadditionalyieldandtomanagetheircapitalrequirementsunderBaselaccords.Relativelylargeinvestmentbanks,suchasJ.P.Morgan[2],originatemostcreditderivativeproducts.Thereisnoexchange-organisedmarketforcreditderivatives;transactionsareconducted‘‘over-the-counter’’,andthereisconsequentlylessliquidity,standardisation,andtransparencythanisencounteredwithstandardexchange-tradedderivatives.Indeed,itisperhapsthisveryfact,coupledwiththecomplexityofpricingcreditderivatives,whichhasdiscouragedmanycorporatetreasurersfromconsideringsuchinstruments.Addtothis,thepublicsuspicionofderivativesingeneral,generatedbytheconspicuousfailuresofcorporationssuchasEnronandBaringsBank,anditisnotentirelysurprisingtoseethatthecorporatetake-upofsuchinstrumentshasbeenslow.Nevertheless,asweshallshow,creditderivativespresentauniqueopportunityforcorporatetreasurerstoaddanewdimensiontotheireffortstomanagerisks.Thecurrentstateofaffairswithregardtocorporateacceptanceofcreditderivativescanbelikenedtothatofthemanagementofcurrencyandinterestrateriskinthelate1980s.Thepotentialforthegrowingfutureuseofcreditderivativesbycorporatetreasurersisclear.Forexample,a1995USsurveyofnon-financialcorporationsrevealedthat52percentofrespondentfirmswere
concernedaboutmanagingtheircreditrisk.Ofthese,18percentexpresseda‘‘high’’concern.Indeed,manyfirmsarealreadyactivelymanagingcreditrisk.AnEnronsurveyconductedbyAccenture[3]foundthat36percentofcompaniesbuycreditinsurance,32percentuselettersofcreditand14percentusecreditderivativestomanagecreditrisk.Whilstnon-financialcompanieshaveadoptedaninterestedbutcautiousapproachtocreditderivativeuse,theoverallleveloftradinginthecreditderivativesmarkethasroughlydoubledineachofthepastfewyears,withthetotalmarketsizegrowingsteadilyfrom$180billionin1997,through$586billionin1999,toover$1.1trillionin2001(BritishBankers’Association(2002)).Thisactivitymostlycomprisesbanksandotherfinancialinstitutionsforwhomcreditriskisnowanimportantfacetofriskmanagement,butitalsocomprisesagrowingnumberofnon-financialfirmsasthemarketstartstoprovidethecomfortlevelsthattheirfinancedirectorsrequire.
2.1Principalcreditderivativeproducts
Therangeofcreditproductsavailableislimitedlargelybytheperceivedneedforthemandthecreativeimaginationsofthefinancialengineersputtingtheproductstogether.Sincetheyaretradedover-the-counter,creditderivativescanbetailoredtosuittheparticularneedsofthepurchaser.However,underthetutelageoftheinstitutionalmarketforsuchinstruments,thefollowingfourmaintypesofcontracthaveemergedinthedrifttowardsstandardisation[4](CFOEurope.com,1998a):
(1)Creditdefaultswaps(CDSs)
(2)Totalreturnswaps(TRSs)[5]
(3)Creditspreadoptions
(4)Credit-linkednotes
Forreasonsofspace,thispaperwillonlyconsidercreditdefaultswapsandtotalreturnswaps[6].
CDSshavebyfarconstitutedthemostpreponderanttradeinthemarket.In2001,forexample,single-nameCDSs[7]represented45percentofthetotalmarketforcreditderivatives(BritishBankers’Association,2002).Conceptually,theyarethemoststraightforwardinstrumenttounderstand.Insimpleterms,aCDSeffectivelyallowstheownerofanunderlyingcreditsecuritytopasstheriskofdefaulttoabuyeroftheCDS.Forexample,FirmAowns￡1mnominalofthebondsofFirmB,whichareredeemablein5years’time.ConcernedaboutitsexposuretoFirmB’sriskofdefault,FirmAmaypurchaseafive-yearCDSfromabankonthenominalamountof￡1m.Thismaybeacquiredbyanupfrontcashpaymenttothebankorbyaspecifiedannualpayment.Shouldapre-specified‘‘creditevent’’occur,thebankwillmakeapaymenttoFirmA,andtheCDSwillceasetoexist.Thedetailsofthecreditevent,andoftheprecisepayment,areamatterfornegotiationbetweenFirmAandthebank[8].Atypicalarrangementstipulatesthatthe‘‘creditevent’’isadefaultoncouponorprincipalrepayments[9].Thepaymentondefault,receivedbyFirmAfromthebank,mightbe,forexample,the￡1mnominalvalueofthebond,lessthemarketvalueofthedefaultedbond,aspecifiednumberofdaysafterdefault.
Atotalreturnswap(TRS)isanagreementbetweentwopartiestoswapcashflowsandotherreturns,overaspecifiedperiod.ThepurchaseroftheTRSacquiresfromthesellerthereturnsofareferencebondorotherasset.Thatis,purchaseracquiresanamountequivalenttoanycouponorotherpaymentsduefromtheasset,alongwithanyUseofcreditderivatives763
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764capitalgainsorlossesarisingfromchangesinthemarketpriceofthatasset.Inreturn,thebuyerpaysafloatinginterestratetotheselleroverthedurationofthecontract.ThisinterestrateisusuallyLIBORplusaspread.ThebuyeroftheTRSownsapositionthatissimilartoapositionintheunderlyingitself,inthatbuyerpartakesofthereturnstothatasset.Importantly,however,thebuyerdoesnothavetomakeanyupfrontinvestmentforthis.
Asalreadynoted,severalothertypesofcreditderivativeexistandareregularlytradedintheOTCmarket,includingcreditspreadoptionsandcredit-linkednotes.Intheremainderofthispaper,weillustratetheuseofcreditderivativeswithsomesimpleexamplesoftheuseofCDSs;thereafter,wefocusourattentionontheTRSasapotentialtoolofthecorporateuser.Althoughnotthemostcommonlytradedinstrumentatpresent,theTRSprovides,undercertaincircumstances,aninterestingmixofcreditandinterestrateprotection.Itisthusapotentiallyusefultoolforthecorporatetreasurerlookingtomanagenotonlyinterestrateexposure,butalsocreditexposure.
3.Inter-investorcreditderivativesmarketandnon-financialcorporations
Wenextconsidertheargumentsinfavourof,andagainst,theexistenceofaninter-investormarketincreditderivativesfromthenon-financialcorporationperspective.Approximately95percentormoreofthecreditderivativesmarketistradedbetweenfinancialinvestors[10].Doesthismarkethelpcorporationstoissuedebt,ordoesitadverselyaffectthecorporateloanmarket?Fromacorporateperspective,therearefivemainadvantagestotheexistenceofthismarket:
(1)Sinceinsurancecompaniesaremajornetsellersofcreditprotection,creditriskfrombankloanscanbediffusedoveralargerpoolofinvestors.Thisincreasesthedemandforcorporatecreditandsoimprovesliquiditythatshouldleadtomoreefficientpricing,lowerfuturecreditspreadsandimprovedmanagementofcreditrisk.
(2)Thepresenceofacreditderivativesmarketshouldenableanygivencompanytohavecloserlinkswithasmallernumberofbanks,asthebankscanusethecreditderivativesmarkettopassonthecreditriskthatwastraditionallytheirpreserve.
(3)Theexistenceofthecreditderivativesmarkethelpsbankstodiversify.Asinvestordiversificationimproves,sothecostofallriskycapital,includingcorporatedebt,shouldfall.
(4)Recentverylargecorporatedefaults,suchasWorldComandEnron,havehadminimalimpactonthebankingsector.Proponentsofthecreditderivativesmarketarguethattheimpactonthefinancialsectorwouldhavebeenmuchgreaterhaditnotbeenforthepresenceofcreditderivatives.
(5)Iffirmshavesparecashorpension-fundmoney,theexistenceofacreditderivativesmarketprovidesanotherassetcategoryforinvestment.AsDavidBlackwood,ICIGroupTreasurer,hasrecentlybeenquotedassaying[11],‘‘Theyhavearoleinpensionfundmanagement.This...islikelytobethemostactive
[areaofusage]forcorporates’’.Suchacomplexandopaquemarketmaywell,though,onlybeanappropriatearenaforthemostsophisticatedpensionfundmanagementschemes.
Thereare,though,severaloffsettingreasonsforcompaniestobeconcernedaboutthepresenceofacreditderivativesmarket:
(1)Severalcommentatorshaveconcludedthatthismarketisthegreatestpotential
threattofuturefinancialmarketstability.Whileseveralleadingauthorities,includingAlanGreenspanandFitchRatings[12],continuetobelievethatthecreditderivativesmarketleadstoanoverallreductioninrisk,others,notablyWarrenBuffett,arguethatthismarketisatickingtimebomb.Unsustainablelevelsofriskare,theyargue,createdbythelackoftransparencyoftheOTCmarketandthedifficultyofpricingsuchcomplexproducts.Thiscouldpotentiallyleadtoahouse-of-cardscollapseinthefinancesector.The2003‘‘BananaSkins’’surveyconductedbytheCentreforFinancialInnovation/PriceWaterhouseCoopersplacedcreditderivativesasthemostimportantsourceofriskcurrentlyfacedbybanks.
(2)Ithasbeenarguedthatbanksarewillingtoloss-leadoncorporateloansin
ordertosecureothermorelucrativebusiness.Thepresenceofacreditderivativesmarket,though,makesthecostofcreditriskmoretransparentandthereforewillenablebankstodemandhighercorporatebondrates[13].This,however,doesnotappearalwaystobethecase.Forexample,Rule(2001)illustratesthat,inSeptember2000,thecreditspreadsonsingle-namecreditderivativeswerelowerthanthecorrespondingspreadsonevenAA-ratedtelecoms’bonds.Inaddition,evenifloss-leadingoncertaincorporateloansisexplicitratherthanimplicit,thismaynotnecessarilycausebankstochangeexistingbusinesspractice.
(3)Thereisevidencethatthecreditderivativesmarketisdistortingtheprimary
marketincorporatebondissues[14].Speculatorssellshorttheunderlyingbondpriortoissueandhedgethecreditrisk,buyingbackthebondonthefirstdayofissue.Theabilityofinvestorstotakeshortaswellaslongpositionsinthecreditriskaddsvolatilitytotheimmediatepost-issuemarket,andpossiblythepre-issuemarket.However,itcouldbearguedthatasthisstrategyincreasesdemandforthebond,thisisgoodfortheunderlyingfirm.
(4)Sincebankshavenoobligationtodisclosetheirdealingsinthecredit
derivativesmarketwiththeirclient,itcouldbearguedthatthemarketmayaffectrelationshipsbetweenthetwo.TimOwen,DirectorofTreasuryatCadburySchweppes,hasbeenquotedassaying[15],‘‘Thebankswhicharelendingtousmaynotbetheonestakingthecreditrisk.Theymaynotcareaboutourperformance’’.
Therefore,whilethecreditderivativesmarketlookssettogrowfortheforeseeablefuture,thecorporatesectorhassomejustificationforitsapparentambivalenceaboutitsexistence.Ontheotherhand,manyofthedisadvantagesofthecorporateuseofcreditderivativesareofthenatureofanexternality:theyaredisadvantagestothecorporatesectoroftheuseofcreditderivatives,ratherthantoindividualfirms.Havingconsideredsomeoftheargumentsthatmaybeadvancedforandagainstthecreditderivativesmarket,wenow,inthelightoftheabovepotentialadvantagesforcorporations,illustratewaysinwhichcreditderivativesmaybeusedtoreducecorporatecreditriskexposure.Useofcreditderivatives765
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7664.ManagingexternalcreditexposureThissectionexamines,bymeansofthreeillustrativeexamples,theuseofcreditderivativesbyafirmtomanageexposuretoexternalcreditrisk.ThefirsttwoexamplesillustratetheuseofCDSstomanagecustomercreditandsovereigngovernmentexposure;theremainingexampleexaminestheuseofTRSs.ThesimplestformofcreditprotectionmaybeachievedbyuseofCDSs.Example1belowgivesatypicalscenario.
Example1
Situation.FirmXisexposedtocreditriskononeofitsmajorcustomers,FirmY,towhichitsellsasignificantportionofitsproductsonconventionaltradecreditterms.Monthlysalestothecustomeraverage￡1m,andthreemonths’tradecreditisallowed.Thus,onaverage,FirmXisexposedto￡3mofFirmY’screditrisk,onamore-or-lesspermanentbasis.
Proposedriskmanagementstrategy.FirmXbuysaCDSwithanotionalamountof￡3monabondissuedbyFirmY.
Propertiesofthiscontract.Inreturnforanannualpayment,thecounterpartywillpaythedifferencebetweenthenotionalamountofthebondofFirmY(￡3m)andthemarketvalueofthisbondinthecasethatFirmYdefaultsonthebond’sobligations.Strengths/weaknesses.ThisstrategyprotectsFirmXfromFirmYgoingbankrupt.Inthiscase,thebondwillbeworthverylittleandthereforetherewillbealargepayoffontheCDSposition.Offsettingthis,FirmXwillnotberepaidonthe￡3moftradecredit.However,ifFirmYdefaultsonitstradedebtbutdoesnotdefaultonitsbonds,thenthisstrategywillnotprotectFirmX.
FirmXcouldalsouseCDSstoprotectitsbondholdingsinacustomerorsupplierfirm.Thussupposethat,insteadofextendingtradecredittoFirmY,FirmXholds￡3mofthebondsofFirmYandprotectsagainstthecreditriskofthosebondsbypurchasingaCDSonanotionalamountof￡3m.FirmYisinthehightechnologysector.ConsiderwhathappenstoFirmX’spositionifthereisageneraldownturnintheeconomicoutlookofthehightechnologysector.Inthiscase,althoughthecreditspreadonthebondsofFirmYmaywiden,loweringthemarketpriceofFirmY’sbonds,nocrediteventhasoccurred.Thus,althoughprotectedagainstdefaultrisk,FirmXisstillexposedtoaconsiderableamountofspread-basedrisk[16].AnalternativehedgingstrategyexistsforprotectingFirmXagainstexposuretoitscustomer’sbonds.AsExample2shows,analternativetousingCDSs,andonethatwilleradicateallofthecreditriskborne,istosellaTRS.
Example2
Situation.Tofacilitatetraderelations,FirmXbuys￡5mofFirmY’sten-year,zerocouponbonds.FirmXhasfundedthepurchaseofthesebondsbyborrowingattheshort-terminterestrate.
Proposedriskmanagementsolution.FirmXentersintoa￡5mnotionalTRSonthebondsofFirmYinexchangeforthebeginning-of-yearLIBOR(excludingspreadsandtransactionscosts),withannualpayment[17].
Propertiesofthiscontract.FirmXsellsthetotalcapitalchangeonFirmY’sbondsinexchangeforLIBORminusaspreadmultipliedbythefacevalueofthebonds.Forexample,supposethattheLIBORrateatthestartoftheyearis4percent.Letthebondvaluebe￡3matthestartoftheyearand￡3.15mattheendoftheyear.ThenFirmXmustpaythetotalreturnonthebonds(￡3.15mà￡3m=￡0.15m)andreceives
LIBOR=4percent￡5m=￡0.2m.FirmXwouldthenreceiveanet￡0.05mfortheyear,minusanytransactionscosts.
Strengths/weaknesses.FirmXhascompletelynettedoutitsposition.ThereceiptofLIBORonitsTRSpositionoffsetstheinterestthatithastopaytofundthepurchaseofthebonds.AnydeclineinbondvalueisperfectlyoffsetbythetotalreturncomponentoftheTRS.Thereare,though,cashflowimplications.Ifinterestratesrise,thenthepriceofFirmY’sbondsfall.AsfarasFirmXisconcernedfromitsbondholdingposition,thisisjustabalancesheettransaction.However,thecashoutflowthatFirmXmustmakeontheTRSfalls,toreflectthedropinbondprice.Therefore,fromacashflowperspective,FirmXgains(loses)ifinterestratesrise(fall).Thisisequivalenttoafutures’‘‘markingtomarket’’effect.
Thissectionconcludesbyconsideringhowcreditderivativescanbeusedtomanagesovereignrisk.Example3concentratesonCDSs,butTRSscouldalsobeusedinthiscase.
Example3
Situation.FirmXaboveisalsoconsideringenteringintoaninfrastructureprojectinadevelopingcountry,butisconcernedthatthegovernmentmaynotbeable,orwilling,tofulfilitspaymentobligationsinthefuture[18].
Proposedriskmanagementstrategy.FirmXbuysaCDSonthesovereigndebtofthedevelopingcountry.The‘‘creditevent’’stipulatedbythecontractwouldbeadowngrading(ratherthanoutrightdefault)oftheunderlyingbond
Strengths/weaknesses.Bystipulatingthatthecrediteventisadowngrading,notadefault,ofthesovereigndebt,FirmXisprotectingitselfagainstthepossibilitythatthedevelopingcountrydefaultsonitstrade,butnotfinancialmarket,agreements.Anycommercialdefaultwouldbelikelytotriggerabonddowngrading.However,thereisstillnotperfectcorrelationbetweenthebusinessandbondrisks,meaningthatthisisnotperfectprotection.Whetherthisispreferabletopoliticalriskinsurancewilldependontherelativetransactionscosts[19].
5.Managinginternalcreditexposure
Whilstthemostobviouscorporateuseofcreditderivativesisformanagingthecreditrisksofcustomersand/orsuppliers,anotherinterestingpossibleapplicationrelatestothepotentialforcompaniestotradeintheirowncreditrisk.Therearetwomaincircumstancesinwhichthismaybeparticularlyadvantageous.First,acompanymaywishtobuycreditprotectiontohelpsecurefutureborrowingrates.InthefirstexamplegiveninExample4,asimplecaseispresentedtodemonstratehowacompanycouldachievethisbysellingthetotalreturnsonitsexistingcorporatedebt.Ifthefuturecostofcorporateborrowingweretoincrease,causedeitherbyachangeininterestratesorbyanincreaseinthecreditspread,thenthiswouldleadtoacontemporaneousfallinthepriceoftheirexistingbonds.Asthederivative’spositionisshortinthesebonds,thisprovidesaneffectivehedge.Inthiscase,thecompanyis‘‘buying’’itsowncreditprotection.Inthesecondcase,managersmaywishto‘‘sell’’creditprotectionontheirownfirmiftheybelievethatthecreditspreadontheirexistingdebtistoohigh.Thecompanycanthenreclaimonthederivativesomeofwhattheyarelosingonthehighborrowingrate.ThesecondexamplegiveninExample5showshowTRSscanbeusedinthiscase.AmoredetailedanalysisofExamples4and5isgivenintheappendix.Useofcreditderivatives767
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768Example4Situation.FirmXhaspreviouslyundertakenamajorbondissue.Itwishestoextendthisissuenextyearandwishestosecuretheamountthatitwillreceive.Proposedriskmanagementstrategy.FirmXentersintoaTRSonitsownbondsinexchangeforthebeginning-of-yearLIBOR(excludingspreadsandtransactionscosts),withannualpayment.Propertiesofthiscontract.ByreceivingLIBORontheTRS,FirmXcanperfectly
identify,attheoutset,thecashinflowfromthisderivative’sposition.Thecashoutflow–thetotalreturnonitsownbondoverthenextyear–isnotknowninadvance.However,changesintheexistingbondvalueperfectlyhedgeschangesinthereceiptsfromthenewbondissue,andthereforethisshouldbearisk-freeinvestmentstrategy.
Strengths/weaknesses.Thisstrategyreliesontheremainingmaturityoftheexistingbondsmatchingthematurityofthenewbonds.Thisisbecausethesensitivityofcorporatebondpricesdependsonbothinterestratemovementsandchangesincreditrisk.Thesensitivityoffixedincomesecuritiestochangesininterestratesisafunctionofthedurationandconvexityoftheseassets.Theproposedinvestmentstrategyisrisk-freeonlyifthesecharacteristicsmatchforthenewandoldbonds.Therefore,whilethisisarisk-freestrategyforanextensionofanexistingbondissue,itmaynotbeaperfecthedgeforanewissueofbonds.
Example5
Situation.FirmZhasissuedbondsandbelievesthatthepriceithasreceivedonthisissuewastoolowbecausethemarketoverestimatedthecreditriskofthefirm.Atthesametime,FirmZwishestoprotectitselfagainstthebusinessriskofaclient,FirmX.Proposedriskmanagementstrategy.FirmZentersintotwoTRSs.Onthefirst,itpaysLIBORinexchangeforreceivingthetotalreturnonitsownbond.Onthesecond,itreceivesLIBORinexchangeforpayingthetotalreturnonFirmX’sbond.
Propertiesofthiscontract.TheLIBORcomponentofthetwoTRScontractsexactlyoffsetseachotherandthereforeFirmZiseffectivelyswappingthetotalreturnsonX’sbondforthetotalreturnonitsownbonds.
Strengths/weaknesses.Aswiththepreviousexample,itisimportanttomatchthedurationandconvexityofthetwobondstoensurethatthecontracthasnounderlyingexposuretointerestratemovements.Thisexplainswhyitisnecessarytohavetwo,offsetting,TRSsratherthanjustone.SinceFirmZthinksthatitsbondsweresoldtoocheaply,bybuyingthetotalreturnsonthesebondsitisexpectingtomakeanabnormalprofit.Ofcourse,managementmaynotbeabletoestimatethecompany’sfuturecreditriskbetterthanthemarket.Indeed,thereissomeevidenceofover-optimismbyestablishedmanagement(Heatonm,2002),andthusadangerthattherewillbeunjustifiedover-applicationofthistechnique.FirmZwillalsobeexposedifthepriceofFirmX’sbondsriseasaconsequenceofadropinitscreditrisk.However,sinceFirmXisaclientofFirmZ,themanagersofFirmZwouldhopethatthisimprovementinthefortuneofFirmXwouldbeaccompaniedbymoreunderlyingbusiness.
6.Conclusion
Thispaperhasprovidedaconciseintroductiontothecorporateuseofcreditderivativestomanagetheircreditrisk.Whilsttheuptakeofcreditderivativesbycorporatetreasurershasbeenslowuptothepresenttime,wehaveattemptedtoillustrate,bymeansofsimpleexamples,thatthescopeforcorporateuseoftheseinstrumentsiswide.Itisunderstandablethatcorporationshavetreatedtheuseof
creditderivativeswithawaryeye,giventhefactthatthemarketisstillinarelativelyearlystageofdevelopment.WhilstorganisationssuchastheInternationalSwapsandDerivativesAssociationhavemadestridesinattemptingtostandardiseandclarifycontractterms,themarketstillsuffersfromalackoftransparency.Inparticular,thereissomeconcernthatthefurtherdevelopmentanduseofthecreditderivativesmarketwillerodecloserelationshipsbetweenfirmsandtheirbankers,andthatthemarket,farfromaddingdiversificationandloweringriskpremiums,willaddtotheriskofa‘‘houseofcards’’effect.Whethersuchconcernsarejustifiedremainstobeseen.Asthemarketmaturesanddevelops,therewillbeaneedforfurtherresearchintotheimpacts,beneficialorotherwise,ofthecreditderivativesmarketonthecreditmarketingeneral,andindeedontheintegrityofthefinancialsystemasawhole.Onacompanylevel,however,creditderivativesprovideaversatile,andpossiblycheaper,alternativetomoretraditionalinsuranceproducts.Thisfactiswitnessedbytheobservationthatmanyinsurancecompaniesnowusethecreditderivativesmarkettotradeonsomeoftheirowncreditrisk.
Notes
1.See,forexample,GuayandKothari(2003).
2.TheBritishBankers’Associationestimatethat,in1999,forexample,banksaccounted
for63percentofthebuyside,and47percentofthesellsideofthemarket.Thispercentage,however,hasbeendecliningovertime,withinsurancecompaniesinparticularbecomingimportantplayers.BBAestimatethatin1997/98,insurancecompaniesrepresented10percnetofthesellside.By1999,thispercentagehadrisento23percent.
3.‘‘Managingriskwithcreditdefaultswaps’’,CorporateFinance,August2001.
4.Animportantefforthasbeenmadeinrecentyearstobringadegreeofstandardisation
toover-the-counterderivativeproductdocumentation,includingcreditderivatives.AmajorpartofthisstandardisationefforthasbeenledbytheInternationalSwapsandDerivativesAssociation(ISDA).ReadersinterestedinviewingsomeofthestandardiseddocumentationshouldconsulttheISDAwebsite:.
5.Althoughtheacronym‘‘TRS’’willbeusedthroughoutthepapertorefertototalreturn
swaps,thisacronymisnotstandardintheliterature.Thetotalreturnswapissometimesalsoreferredtoasatotalrateofreturnswap.
6.Readerswhoareinterestedintheapplicationsofotherkindsofcreditderivativemay
consultAnsonetal.(2004)forgeneralcoverageofcreditderivatives,anddetaileddescriptionsofspecificinstruments,includingCDSs,TRSs,credit-linkednotes,creditspreadoptions,andsyntheticcollateraliseddebtobligations.Severalinterestingarticlescovercreditderivativesinanon-technical,accessiblestyle:CFOEurope.com(1998a,b);Ivey(2002);Seyfried(2001)(onCDSs);Nordoneetal.(2001)andSenior(1999).
7.Single-nameCDSsarebasedonthedebtinstrumentsofasinglecompanyorotherentity.
‘‘Basket’’CDSsarealsotraded,witha‘‘basket’’ofcompanies’debtinstrumentsastheunderlyingsecurities(seeAnsonetal.(2004,Chapter3)foradetaileddescriptionofbasketCDSs).
8.In1999,alistofeightpossiblecrediteventswascompiledbyISDA,intheirCredit
DerivativesDefinitions.Theseeventsmaybeselected,individuallyorincombination,bypartiestoaCDS,indrawingupaspecificcontract.Thelistedcrediteventsinclude,forexample:bankruptcy;merger;credit-ratingdowngrade;failuretopay(amountsdue);andrestructuring.
9.ThedetailedandexactdefinitionofacrediteventisacrucialaspectofaCDS,and
shouldbeconsideredcarefully.Useofcreditderivatives769
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32,9
77010.‘‘Treasuriesfightshyofcreditderivatives’’,CorporateFinance,October2002.11.R.Pink,‘‘Corporatecreditderivatives:aretheyirrelevant?’’CorporateFinance,October2003.12.‘‘Globalcreditderivatives:aqualifiedsuccess’’,FitchRatings,September2003.13.See,forexample,N.deTeran,‘‘Creditderivatives’knock-oneffects’’,TheBanker,9June2003.
14.See,forexample,thesectionon‘‘Risksarisingfromcreditderivatives’’,FinancialRiskOutlook,2004,FinancialServicesAuthority.
15.‘‘Passingthecreditriskparcel’’,CFOEurope.com,September1998.
16.Ifa‘‘creditevent’’isdefinedasadowngradeinthebond’srating,thenacertainamountofthisspreadriskmaybehedged;therestillremains,however,aresidualamountofcreditspreadriskassociatedwiththebondsofFirmY.
17.Themarketpriceofthebondiswellbelowthefacevalue,sincethebondiszero-couponandalongwayfrommaturity.Therefore,evenifthebondreturnissomewhathigherthanLIBOR,FirmXwillreceiveanetcashinflowfromtheTRSifthespreadisignored.Giventhis,itislikelythatthespreadontheTRSwillbereasonablyhighinthiscase.
18.Thecompanycanprotectagainstthispoliticalriskintheabsenceofacreditderivativesmarket–forexample,itcouldpurchasepoliticalriskinsuranceeitherprivatelyorfromtheExportCreditsGuaranteeDepartment.
19.Onepotentialargumentinfavourofcorporateinterestinthecreditderivativesmarketistheobservationthatmanyinsurancecompaniesarenowutilisingcreditderivativestopassonsomeoftheirinsuredrisk.Ifacompanycandothisdirectly,thenperhapstheycanavoidsometransactionscosts,andthusinsuretheirownrisksmorecheaply.
20.Amoreprecisemethodofconvertingfromthecontinuous-timeOrnstein–Uhlenbeckmodelstoadiscrete-timeinterestratemodelisgivenbyNowman(1997).Estimatesof??;??rand??derivedusingNowman’smethodareverysimilartothosereportedhere.
XistakenfromEltonetal.(2001,Table1,21.Foranygivencreditrating,thevalueof??t,TPanelA)fortheindustrialsector.
22.Thezerostandarddeviationinthe‘‘Xunchanged’’caseisaresultofthebondsofFirmZandFirmXhavingthesamecreditspreadinthiscase.Therefore,whatevertheinterestrate,thepriceofthesetwobondswillbethesameandthepayofftothederivativespositionisnon-stochastic.
References
Anson,M.J.P.,Fabozzi,F.J.Choudhry,M.andChen,R.-R.(2004),CreditDerivatives:Instruments,
Applications,andPricing,JohnWiley&Sons,Inc.,Somerset,NJ.
BritishBankers’Association(2002),CreditDerivativesReport2002.
CFOEurope.com(1998a),‘‘Passingthecreditriskparcel’’,September1998,availableat:
/displayStory.cfm/1735713.
CFOEurope.com(1998b),‘‘Compromisingpositions’’,September1998,availableat:
/displayStory.cfm/2020411.
Chen,K.G.,Karolyi,G.A.Longstaff,F.A.andSanders,A.B.(1992),‘‘Anempiricalcomparisonof
alternativemodelsoftheshort-terminterestrate’’,JournalofFinance,Vol.47,pp.1209-27.Elton,E.J.,Gruber,M.J.Agrawal,D.andMann,C.(2001),‘‘Explainingtheratespreadon
corporatebonds’’,JournalofFinance,Vol.56,pp.247-77.
Guay,W.andKothari,S.P.(2003),‘‘Howmuchdofirmshedgewithderivatives?’’,Journalof
FinancialEconomics,Vol.70,pp.423-61.
Heaton,J.B.(2002),‘‘Managerialoptimismandcorporatefinance’’,FinancialManagement,Vol.31
No.2,Summer,pp.33-45.
Ivey,J.(2002),‘‘Treasuriesfightshyofcreditderivatives’’,CorporateFinance,Vol.215,pp.26-29.Nordone,M.,Reyfman,A.andToft,K.(2001),‘‘Hedgingyourbetsoncreditrisk’’,Corporate
Finance,Vol.201,p.36.
Nowman,K.B.(1997),‘‘Gaussianestimationofsingle-factorcontinuoustimemodelsoftheterm
structureofinterestrates’’,JournalofFinance,Vol.52,pp.1695-706.
Rule,D.(2001),‘‘Thecreditderivativesmarket:itsdevelopmentandpossibleimplicationsfor
financialstability’’,FinancialStabilityReview,No.10,pp.117-40.
Senior,E.,(1999),‘‘Howcreditderivativescancontrolcreditrisk’’,CorporateFinance,Vol.175,
pp.38-41.
Seyfried,B.(2001),‘‘Managingriskwithcreditdefaultswaps’’,CorporateFinance,Vol.201,
pp.37-38.
Vasicek,O.(1977),‘‘Anequilibriumcharacterizationofthetermstructure’’,JournalofFinancial
Economics,Vol.5,pp.177-88.
Appendix
Inthemainbodyofthetext,wehaveconsideredinaheuristicfashionhowafirmmightutiliseCDSsandTRSstoprotectitselffromcreditrisk.Inthisappendix,Examples4and5areexpandedupon.Inordertoquantifytheeffectsofthehedges,itisfirstnecessarytomodeltheinterestrateprocess.Itisassumedthattheshort-terminterestratertfollowsadiscreteOrnstein–Uhlenbeckprocess[20]:
ràrtà1Tt????trtàrtà1???e??
where??t$Ne0;1T.Thisisamean-revertingmodelwhere??risthelong-runaverageinterestrateand??determinesthespeedofadjustmentbacktothislong-termmean.Thevaluesof??;??rand??areestimatedusingtheprocedureofChenetal.(1992).Theinterestratedataaremonthlyone-monthsterlinginterbankmiddleratesovertheperiodMarch1973toAugust2003,takenfromDatastream.Thespotestimatesof???0:0154;??r?0:0783and???0:0070wereobtained;theseestimatesareusedinthemodelbelow.
FromVasicek(1977),thetermstructureofinterestratesisknowninthiscase.IfRt;TisthecontinuouslycompoundedredemptionyieldattimetonaTreasurystripthatmaturesattimeT,then:
Rt;1??q1??2???rtà??2??Useofcreditderivatives771
Rt;Tihi2?rtàRt;1??h??2à??eTàtTà??eTàtT1àe?Rt;1tt31àe??eTàtT4??eTàtT
whereqisariskaversionterm.Giventheparameterestimates,ifthecurrentshort-termrateis4percentandthelongendis6percent,thisimpliesthatq=0.187.Inthissection,itwillbemoreconvenienttoworkwithnon-compoundedinterestrates.IfPtTreasuryisthemarketpriceattimet;TofaTreasurystripthatmaturesattimeT,thendefine
100
e1t??t;TT?PtTreasury?100exp?àeTàtTRt;T??;T
where??t;Tisthediscreteper-periodreturnonthestrip,sothat??t;t?rt.
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NowsupposethatFirmXhasazero-couponbondthatmaturesattimeTandhascurrent
X
marketpricePt,T.Thepriceofthebondisgivenas
PXt;T?
100
e1t??t;Tt??Xt;TT
772
where??Xt;Tisthecreditspreadonthisbond.
ExpansionofExample4
FirmXhasaten-yearzero-couponbondinissueandwishestoextendthisissuenextyear.Thatis,itwillissueanewnine-yearzero-couponbondinoneyear’stimeonthesametermsastheexistingzero-couponbond.Thecompanywishestoprotecttheamountitwillraisefromthisbondissue.
X
nextyear.ToprotectagainstinterestForeachnewbondissued,thecompanywillreceiveP1,10
rateandcreditspreadmovementsoverthenext12months,itentersintoaTRS.Itsellsthereturnonitsexistingbondinexchangefortheone-yearLIBORrate(ignoringtransactionscostsandspreads).Fromtheinterestratemodelgivenabove,thisisestimatedtobe4.179percentifthe
XX
currentshort-termrateis4percent.Thatis,itwillpayoutP1,10àP1,10andreceive￡4.179forevery￡100offacevalueofthenewissue.Therefore,thecompanyhascompletelysecureditsnew
X
bondreceiptstobeP1,10t4:179per￡100offacevalue.
Isthisagooddealforthecompany?IftheexistingbondiscurrentlyA-credit-rated,thenthe
XX
creditspreadonFirmX’sbond[21]is??1,10?0:785percent,implyingthatP1,10?57:265.Thecompanyhasthereforesecuredreceiptsof￡61.444nextyear.Whatwouldtheyhavereceivediftheyhadleftthepositionunhedged?Overthecurrentyear,FirmX’sexistingbondcouldretainits
XX
currentrating(??1,10?0:779percent),beupgradedtoAA(??1,10?0:589percent)ordowngraded
X
toBBB(??1,10?1:184percent).Toestimatepotentialreceiptsfromtheunhedgedbondsalegiventhestochasticrisk-freerate,10,000simulationsarerun.TheresultsarereportedinTableAI.Therefore,providedthetotaltransactionscostsand￡61.444à￡60.779?67bp,thenthisriskprotectionis‘‘costless’’.
spreads
are
less
than
ExpansionofExample5
Acompany,FirmZ,hascurrentcreditratingofBBBona￡10m,ten-yearzero-couponbondbutbelieves,givenitsinformationalasymmetry,thatitstruedefaultratingisclosertoA.
Xupgraded(￡)
TableAI.
Thedistributionofcashflowreceiptsfromanunhedgednewbondissue
Meanreceipt
StandarddeviationTop95thpercentileLower5thpercentile
61.7713.61767.89556.007
Xunchanged(￡)
60.7793.55366.69355.117
Xdowngraded(￡)
58.7223.41964.50953.272
Xupgraded
TableAII.
Thedistributionofcashflowsfromhedgingunderlyingbusinesscreditexposure
Mean
StandarddeviationTop95thpercentileLower5thpercentile
310,3516,453320,593299,389
Xunchanged209,600
0209,600209,600
Xdowngraded
215,29913,337237,929194,118
Managementisconfidentthatitsbondswillbeupgradedduringthecurrentyear.Thatis,ZZ?1:18percentbutmanagementisconfidentthat??1,10?0:779percent.FirmX,ofthe??1,10previousexamples,isacustomerofZ.IfFirmX’sbondisre-gradedduringtheyear,thenFirmZestimatesthatthiswillaffectthevalueofitsownbusinesscontractswithFirmX.Anupgrading(downgrading)ofFirmXwillincrease(decrease)thevalueofZ,inyear1terms,by￡0.2m.
FirmZdecidestoenterintotwoone-yearTRSsonanotionalvalueof￡10m.ItbuysthetotalreturnsonitsownbondsandsellsthetotalreturnsonFirmX’sbonds.Ignoringspreadsandtransactionscosts,andifjustonepaymentismadeattheendoftheyear,thenthecashflowfromZXZXtheswapisP1,10tP1,10àP1,10àP1,10.Thereisalmostnoexposuretochangesininterestratesheresincethedurationsofthetwobondsarethesame.Estimatedcashflowsfromthenetbusinesstderivativespositionarecalculatedover10,000simulationsofthestochasticinterestrate[22](TableAII).
Inthiscase,thecompanyisexploitinganinformationalasymmetrytomakemoneyonitsownbondswhilesimultaneouslyhedging￡400,000ofeconomicexposuretoaclient.Byusingtwoswapsratherthanone,thenetinterestrateexposureisverylow.
Correspondingauthor
MarkC.Freemancanbecontactedat:m.freeman@bradford.ac.ukUseofcreditderivatives773
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