Product Description

The growth of the credit derviatives market has produced a liquid market in credit default swaps across the credit curve, and this liquidity has led many investors to access both the credit derivative and cash bond markets to meet their investment requirements.

This book investigates the close relationship between the synthetic and cash markets in credit, which manifests itself in the credit default swap basis. Choudhry covers the factors that drive the basis, implications for market participants, the CDS index basis, and trading the basis.

Credit market investors and traders as well as anyone with an interest in the global debt markets will find this insightful and rewarding.

THIS BOOK QUALIFIES FOR 7 PD CREDITS UNDER THE GUIDELINES OF THE CFA INSTITUTE PROFESSIONAL DEVELOPMENT PROGRAM.

Product Details

• Amazon Sales Rank: #506300 in Books
• Published on: 2006-10-01
• Original language: English
• Number of items: 1
• Binding: Hardcover
• 195 pages

About the Author
Moorad Choudhry is head of Treasury at KBC Financial Products in London. He is a visiting professor at the Department of Economics, London Metropolitan University; a visiting research fellow at the ICMA Centre, University of Reading; a senior fellow at the Centre for Mathematical Trading and Finance, Cass Business School; and a fellow of the Securities and Investment Institute. Choudhry is the author of numerous books, including Fixed-Income Securities and Derivatives Handbook.

Customer Reviews

This book could be boiled down to an article.
The book is 195 pages total. The first 60 pages explain what CDS, z-spread, and asset swap spread are. While this is useful information, chances are, if you are buying a book about CDS basis, you will already know this stuff. And if you dont, wikipedia or any other online source can concisely explain it.

The last 50 pages includes definitions and appendicies. In between, you get a lot of repetitive information. Every chapter starts out with a 2-3 page summary of what you just read.

Chapter 3 is really the only useful part of the book - it outlines the 10 or so factors that drive basis. I certainly learned a lot here but it was in the course of 10 pages or so.

The final chapter talks about "trading the basis." I was disappointed to read that they are simply telling you how to execute the trade...ie, buy $10MM notional, sell X, hedge with futures. It really doesnt help with idea generation which is what I was hoping to see.

Very Useful For Practitioners
Choudhry lays out the relationship between cash and synthetic fixed income instruments: 1) for cash bonds, the different ways to measure the cash flows, swapping fixed to floating, using ASW, I spread, Z spread, etc., and the pro's and con's of each measurement. 2) For CDS, there is a brief primer on the CDS product structure, and discussion of CDS pricing methodology (both mathematically and in layman's terms). He then lays out techniques for hedging and basis trading and presents examples. There is discussion of market supply/demand influences.

The emphasis is hands-on usability for the practitioner. He presents examples using the Bloomberg & some spreadsheets. Although several approaches to CDS pricing theory are presented (including some math that I'm not knowledgable enough to evaluate), CDS theory is not explored or debated in great detail. This level of theory is not the primary focus of the book. The book is NOT targeted to heavy duty quants or theoreticians.

There are a couple areas where I would have appreciated a bit more diligence. Choudhry himself points out one example where the values in the printed Bloomberg screen differ slightly from the book's text (couldn't they have updated one or the other before going to print?). In another case, I was unsure about the consistency of treatment in different parts of the book regarding one of the spread measurements. In this case I will probably buy one of his other books where the issue is examined in greater detail.

Overall, I found this book VERY useful and well worth reading.

Good introduction, but only to the basis
Please note "basis" in the title. It's a fine introduction to CDS generally and a first pass at pricing (but nothing deep). But it is undermined by the *unhelpful* way in which it uses Bloomberg screens and spreadsheet screen shots (w/o actual spreadsheets). It is short, here are my notes from the six chapters:

1. CDS Primer. He compares a bond (which compensates the investor for credit, funding, interest rate and currency risk) to an asset swap (compensation for credit and funding risk) to a CDS (compensation for credit risk only). He helpfully shows how a CDS transfers unfunded credit default risk.

2. Muddled introduction to swap rates which is decent but unduly confusing becuase it lacks a good setup on swaps. The point is to introduce the CDS basis which equals the difference between the CDS spread (i.e., the premium paid by the protection buyer to the protection seller) and the spread on the corresponding bond (Z spread) or asset swap. In other words, in theory, we start with the idea that the CDS basis should be zero because the premium received on sold protection (CDS premium) on an underlying bond should equal the credit spread on the same underlying bond, if we were to fund the bond directly. The book is then largely about why this isn't true, why the basis will vary from zero.

3. Factors behind the basis. I think this is helpful. The author distinguishes fundamental factors from market factors. Both contribute to the CDS basis. But their difference I think is important. Fundamental factors can be designed into the contract; i.e., in theory, the counterparties will demand compensation for fundamental factors. For example, a CDS in unfunded, unlike a bond which is funded. If an investor has high funding cost, he/she will prefer the CDS and this drives down the basis. Another, more topical fundamental factor is counterparty risk. The protection buyer assumes counterparty risk (historically, margin collateral only mitigates counterparty risk); this drives down the basis. I would argue that consistent underpricing of true counterparty risk (enabled by M2M and collateral netting practices) enabled the unfunded CDS market to grow in the first place; if counterparty risk were accurately priced (or posted collateral really covered counterparty risk) in the first place, it's not clear the CDS market would have had *half* its appeal.

Market factors include supply/demand, liquidity, and a few other items which (IMO) can classify into supply/demand anyhow. The reason it's helpful to grasp market factors is: typically our pricing models cannot capture technical (market) factors. That's why we don't expect pricing models to be accurate; due to techical factors, we expect instruments to "trade rich" or "trade cheap" relative to the price given by our models.

4. and 5. Illustrate the calculation of the *adjusted* CDS basis which is the same CDS basis above (i.e., CDS basis - Z spread) but the bond spread is adjusted/informed by the default information contained in the CDS market quotes. Because the spreadsheet example is clumsily displayed, it looks harder than it should.

6. Gives some trade applications, which are interesting. Negative basis trades are simply: buy the bond and buy (CDS) protection on the same bond, if the CDS spread is low. But the "advanced" examples are difficult only because the book delegates explaining terms likek DV01 to another book (?!).

The appendix gives an unwitting example of unnecessary complication. Appendix III shows a spreadsheet to compute the market-implied timing of default from CDS prices (i.e., using the CDS to infer when the bond will default). No spreadsheet is necessary and certainly no need to "goal seek". It is just a breakeven analysis. It can be shown in a few sentences: 1.3 years = $6 MM recovery / $4.6 MM annual premium.