Ensayo Riesgo

TRIAL

AN EMPIRICAL ANALYSIS OF THE DYNAMIC RELATION BETWEEN INVESTMENT-GRADE BONDS AND CREDIT DEFAULT SWAPS

SANDRA MILENA GONZALEZ FIGUEREDO

UNIVERSIDAD PILOTO DE COLOMBIA

INGENIERIA FINANCIERA

RIESGO

BOGOTÁ, D.C.

2013

1. SYNTHESIS

When we speak of swaps, we refer to the type of contract, whereby two parties agree to Exchange specified assets, in this case the bonds and deal with each of the obligations. It is an instrument that is used to reduce the cost and risk of financing of a company or to overcome the barrier of the financial markets.

The swaps market is an unregulated market, which is not monitored by any government agency. As a result, there has been a high degree of innovation in credit default swaps. In addition there is privacy, for the parties involved and each counterparty in credit default swaps, should be to thoroughly analyze the creditworthiness of the counterparty to reduce the risk default on their payments according to the terms of the contract.

The CDS are an indicator that differentiates them from the bonds, their prices and are useful indicators for the measurement of credit risk. It is likely that any system of investment from as a result the selection of actions, produce superior returns with lower risk profile in the credits. If we consider a situation that a portfolio manager wants to make important changes in the proportions of funds invested in different asset classes. The Administrator recognizes that there will be high transaction costs to make changes using the traditional method of selling certain values and replace them with others.

However, there are two forms of deviation from parity, such as very high prices (CDS) that credit spreads for long period of time and small parity deviations which are located with an advantage of prices (CDS), to negotiate associated derivative contracts. These titles are the most liquid of current credit derivatives and their benefit is based on that if an event of credit, i.e. a loss, the buyer compensates for this risk, with the value in the market and the par value of the bonds.

The analysis presented by the reading, is an interesting alternative for the estimation of CDS, in countries where corporate bonds have low liquidity and the credit derivatives market is non-existent. In its application good results can be obtained for CDS on securities in investment-grade, although it tends to overestimate, premiums for those titles that are in the last degree of speculation.

Credit derivatives are financial instruments that are designed to transfer the credit risk of an asset or a portfolio of assets. These are contracts or agreements whereby a part, the protection buyer, acquires an issuer or a group credit risk protection. The counterpart, the seller of protection, is willing to provide such protection for losses arising from the occurrence of a certain event of credit with the expectation of profit when such an event does not occur.

2. OPINION

I. Credit Default Swaps and Credit Spreads

If any event before the expiry of the CDS contract, the seller undertakes to compensate the buyer, though, it may happen that bankruptcy, nonpayment of obligations, failure to comply with obligations, repudiation or moratorium and restructuring, occurs in the company although there are more options to avoid the risk as a title of certificate of deposit term.

The Credit Default Swap Market: There are two models, one the Merton to know the process of the value of the company reaches a limit, Das and Pierides applied the structural model of credit derivatives prices. Earnings from a CD equal in the amount of capital less times main recovery, the sum of the interest rate and the accumulated in the obligation. We can say that the price of CDS is an upper limit on the price of the credit risk, while its extension provides a lower bound. The cash bond markets are relatively iliquidos. Today the CDS markets, is small in spite of its growth is rapid and the imbalances in supply and demand, can cause short-term price movement.

The CDS are derived extra stock traded in London and New York should be considered to negotiate its physical value standard is $10,000,000, his price to 5 years and closing of negotiation is up to 17 hours. In the credit derivative contract is essential to specify who is the issuer or group of issuers of the underlying instrument, which is called a reference entity, what is the expiration date of the contract, which is the credit event giving rise to the coverage and the manner of determining the payment on account of the seller of protection in the event of any occurrence.

In the market of credit derivatives in emerging countries, increased participation instruments are CDS with 85%. The

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