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CBOT Credit Default

Swap Index Futures

Reference Guide
Table of Contents right

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Contract Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Short Lifespan
Rate Up, Price Up
Buy Futures ≈ Buy Protection. Sell Futures ≈ Sell Protection.

Key benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Position Scalability
Administrative Convenience and Low Operational Cost
High-Grade Credit Exposure
Capital Efficiency
Off-Exchange Trading

the cdr liquid 50 index: composition and structure . . . . . . . . . . . . . . . 11

Index Series and Futures Expiries
Selection of Index Components
Maximum Running Spread and Other Index Parameters

The CDR liquid 50 index: some Sylized Facts . . . . . . . . . . . . . . . . . . . . . 14

Financials: CDR Liquid 50 versus CDX

synthetic corporate bond portfolios . . . . . . . . . . . . . . . . . . . . . . . . 17

Long Corporates ≈ Long IRS Futures + Short CDS Index Futures
Short Corporates ≈ Short IRS Futures + Long CDS Index Futures

Pricing cds index futures: Spot versus forward . . . . . . . . . . . . . . . . . 23

Spot ≈ Forward, Generally
Exceptions Depend on the Hazard Rate
Rolling Down the Curve

Appendix 1 – CDS Index Futures Contract Specifications . . . . . . . . . . . . . . . . . . . 29

Appendix 2 – CDS Index Futures Contract Rules . . . . . . . . . . . . . . . . . . . . . . . . 30

Appendix 3 – CDR Liquid 50 NAIG Index Construction and Maintenance Procedures . . . . . 32

Appendix 4 – CMA and CMA DataVision . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37


Since the birth of financial futures, market practitioners have exhorted exchanges to list “corporate bond futures”.
What they envision, typically, are contracts that would be traded and transparently priced on a regulated
exchange, and that would be guaranteed by a centralized clearing house, and that would (by whatever means)
furnish a generic proxy for the price exposure of investment grade corporate bonds.

Chicago Board of Trade Credit Default Swap (CDS) Index futures meet this need.

• CDS Index futures give institutional portfolio managers a simple means of acquiring or laying off
standardized investment grade corporate bond price exposure.

• For many users, CDS Index futures should result in lower administrative costs relative to over-the-counter
(OTC) alternatives.

• As with all CBOT® futures, the guarantee furnished by the Exchange’s clearing services provider
consolidates and virtually eliminates counterparty credit risk, permitting contract users to easily adjust their
asset exposures without tying up credit lines.

• Used in conjunction with CBOT Interest Rate Swap (IRS) futures, CDS Index futures give market
practitioners a simple, flexible means to create and trade synthetic investment grade corporate
bond portfolios.

This reference guide reviews the key features and benefits of CDS Index futures. It then discusses the structure of
the contract’s underlying reference, the CDR Liquid 50TM North America Investment Grade Index (hereafter, CDR
Liquid 50TM) and describes some of the index’s empirical features. It explores in detail how traders and investors
can combine CDS Index futures with CBOT 5-Year IRS futures to achieve an operationally clean and flexible proxy
for generic investment grade corporate bond exposure. It concludes with a discussion of the relationship between
spot values of the CDR Liquid 50 index and the forward values reflected in CDS Index futures prices.

Appendices present a summary of the terms of the CDS Index futures contract, the CBOT Rulebook chapter that
formally defines the contract, the guide to index construction and maintenance procedures for the CDR Liquid 50
index, and an overview of CMA DataVisionTM, the price data source for the CDR Liquid 50 index.


The dramatic growth of credit default swaps marks derivatives market participants and regulators. The
one of the great milestones in the saga of financial action plan that emerged from these gatherings has
derivatives. In the short span from year-end 2004 to accomplished much, including marked reduction
year-end 2006, outstanding notional amounts of US in the backlog of outstanding unconfirmed trades,
dollar-denominated credit default swaps burgeoned clarification of procedures for trade assignment and
from around $6.5 trillion to nearly $29 trillion, clocking novation, and widespread acceptance and adoption
growth of 110 percent per annum. The share of this of more rigorous protocols for the settlement of credit
total that represents index-related (“multi-name”) credit derivatives when credit events actually occur. (See,
default swaps has risen yet faster, from 20 percent in e.g., Federal Reserve Bank of New York, “Statement
2004 to nearly 35 percent in 2006. See Exhibit 1. Regarding Progress in Credit Derivatives Markets”, 27
September 2006,
This achievement has not come without growing
pains. In recent years, regulators have become Despite these efforts – or perhaps because of them
increasingly troubled by the inability of dealers’ – the operational costs of trading and managing OTC
back offices to keep pace with timely capture, credit derivative positions have soared in league with
confirmation, and booking of credit derivative the scale of market activity. This underscores the
transactions. Matters came to a head in September need for exchange-listed contracts to assist market
2005, when the Federal Reserve Bank of New York participants in managing their risk exposures. CBOT
convened the first of a series of meetings with major CDS Index futures are ideally suited to play this role.

30 Exhibit 1
Total Outstanding Notional
Amounts of OTC US Dollar
Credit Default Swaps
Data Source:
Bank for International Settlements

10Dollar Trillions


Dec 04 Jun 05 Dec 05 Jun 06 Dec 06


Contract Features
CBOT CDS Index futures expire quarterly, in March, CDS Index futures expire by cash settlement. There
June, September, and December. The last trading is no physical delivery. CDR LLC will publish the value
day for expiring contracts is the so-called IMM of the pertinent CDR Liquid 50 index series for the
Monday, the Monday before the third Wednesday last day of trading, on the next morning. This index
of the expiry month. value becomes the expiring contract’s final settlement
price. The Exchange’s clearing services provider uses
The underlying reference for CDS Index futures is this final settlement price to determine a final mark to
the CDR Liquid 50 North America Investment Grade market (versus the futures contract’s daily settlement
Index, maintained and published daily by Credit price on the last day of trading).
Derivatives Research LLC (CDR LLC). The CDR Liquid
50 index is simply an arithmetic average of 5-year Two differences between CDS Index futures and
credit default swap spreads quoted on each of the 50 other CBOT financial futures deserve emphasis:
most active names in the US investment grade credit
default swap market. Short Lifespan
One is that a CDS Index futures contract has an
CDS Index futures are quoted as an average credit
unusually abbreviated lifespan, roughly three and a
spread, directly in terms of the CDR Liquid 50 index,
half months from listing to expiration. A newly listed
in basis points and hundredths of basis points. Each
contract begins trading on the business day after
basis point of contract price is worth $500. Each
the CDR Liquid 50 index series that corresponds to
hundredth of a basis point, the contract’s minimum
it has been constituted and announced. The newly
trading increment, is worth $5.
listed contract then coexists with the previously
listed contract for approximately two weeks, until the
At expiration the CDS Index futures contract settles previously listed contract expires.
to the value of the CDR Liquid 50 index on the
contract’s last trading day. Importantly, each futures
Example: Consider a hypothetical March 2007 CDS
expiry references a distinct index series. This means,
Index futures contract. Its underlying reference
for example, that a September CDS Index futures
would be the CDR Liquid 50 index series
contract will expire with reference to a CDR Liquid 50
constituted on the last business day of November
index series that may differ in composition from the
2006 (Thursday, 30 November). The contract would
index series that serves as the underlying reference
begin trading on the first business day of December
for the futures contract that expires the following
2006 (Friday, 1 December) and would expire on
December. (How this relationship works, and why it is
IMM Monday in March 2007 (Monday, 19 March).
so, is explained in detail below. See “The CDR Liquid
It would trade alongside the (likewise hypothetical)
50 Index: Composition and Structure” on page 11.)
December 2006 contract from Friday, 1 December,
through Monday, 18 December, the last trading


day in the December 2006 contract. During this Rate Up, Price Up
time, strategic open interest holders would be able
The other distinction is that CDS Index futures are
to roll their positions from the December 2006
priced with direct reference to an interest rate spread
contract to the March 2007 contract. Among the
– to be precise, a forward-starting credit spread.
many considerations they would take into account
This means that when credit spreads widen generally,
when pricing the roll spread are the differences in
the contract price is likely to rise in value. Conversely,
composition, if any, between the two CDR Liquid
when credit spreads become narrow generally, the
50 index series – 064 and 071, respectively -- that
contract is likely to fall.
correspond to the December 2006 and March
2007 contracts.
This is in contrast to other CBOT financial futures,
such as Treasuries, Interest Rate Swaps, or 30-Day
This listing/expiry timetable strikes a judicious balance
Fed Funds. Because those contracts trade in terms of
between two goals. One is to allow each newly listed
notional asset price, rather than notional interest rate
CDS Index futures contract to run in tandem with the
or interest rate spread, their prices tend to fall when
previously listed contract, long enough to let market
interest rates rise, and vice versa.
participants roll in orderly fashion from one expiry to
the next.
Several examples given below will dramatize the
importance of keeping this distinction clear when
The other is to permit the CDR Liquid 50 index to do
constructing and trading spreads between CDS
what it is designed to do. The futures contract’s short
Index futures and other CBOT financial futures. (See
lifespan enables a comparably short lifespan for the
“Synthetic Corporate Bond Portfolios” on page 17.)
index series that serves as its underlying reference.
The single-name credit default swaps selected as
Buy Futures ≈ Buy Protection.
index components will have been chosen on the basis
Sell Futures ≈ Sell Protection.
of their trading activity. However, one of the realities of
both the corporate bond and OTC credit derivatives For those familiar with OTC credit default swaps,
markets is that liquidity can, and often does, migrate a convenient rule of thumb is that owning a long
abruptly from one corporate reference to another. In position in CDS Index futures is similar to owning
view of this, the brief lifespan of the futures contract protection. Given a general widening of credit
and its companion index series is intended to increase spreads, a CDS Index futures contract price will tend
the chances that the 50 names in the index series to rise, and contract longs should benefit. If instead
might remain active through contract expiration. there is a general narrowing of credit spreads, then
CDS Index futures prices will tend to fall, and contract
longs will have to pay variation margin on the ensuing
marks to market. Obviously the converse holds too:
A seller of CDS Index futures assumes exposure
broadly similar to a protection seller’s position in
OTC credit default swaps.


Key Benefits
Users of CBOT CDS Index futures gain several High Grade Credit Exposure. The credit
important benefits from the contract design. guarantee of the CBOT clearing services provider
makes CDS Index futures comparable to the
Position Scalability. CDS Index futures offer strongest counterparty credits in the OTC market.
a convenient and standardized means to obtain Among its many benefits, this obviates the need
exposure, long or short, to a generic investment for entering into potentially cumbersome bilateral
grade corporate credit spread, without having to collateralization arrangements to alleviate
own either an OTC credit default swap or a spread counterparty credit exposure.
position between, e.g., corporate bonds and plain-
vanilla interest rate swaps. Unlike OTC credit default Capital Efficiency. Besides virtually eliminating
swaps, positions in CDS Index futures can be entered credit risk, the clearing house guarantee means that
or liquidated, scaled up or down, without extensive futures position holders need not reserve significant
contractual documentation and without leaving amounts of capital against the risk of adverse moves
behind a book of non-nettable or non-offsetting in credit spreads. That is, by using CDS Index
OTC swap contracts. futures portfolio managers and credit spread traders
may substitute (inexpensive) risk management for
Administrative Convenience and Low (expensive) capital.
Operational Cost. Using CDS Index futures
eliminates the administrative (e.g., accounting, Off-Exchange Trading. CDS Index futures are
manpower, record-keeping) costs frequently required eligible for a wide variety of bilaterally negotiated
in maintaining a book of OTC credit derivatives. off-exchange transactions. These include:
Moreover, cash settlement means there are no trailing
contractual obligations after contract expiration. The • Wholesale trades in which a buyer and seller
financial obligations entailed in CDS Index futures can bilaterally trade a block of CDS Index
expire with the contract, after the final mark to futures at a mutually agreeable price, as long
market. For this reason, among others, CDS Index as the scale of the block transaction is large
futures make synthetic credit spread exposure readily enough to qualify. The minimum admissible
available to market participants who cannot be, or size for block trades in CDS Index futures
who would prefer not to be, directly involved in OTC is 100 contracts.
credit derivative transactions.
• Exchange-for-Physical (EFP) trades in
which a buyer acquires CDS Index futures
Transparency. By their nature and structure,
from a seller at a mutually agreeable price.
futures markets allow participants with differing
At the same time, the futures buyer sells (and
information sets and outlooks to discover the
the futures seller buys) an equivalent amount
equilibrium price of the moment. By making price
of a credit spread position in cash securities,
information available for all to see, CDS Index futures
for which the credit spread dynamics are
furnish a useful reference point – and a daily mark to
reasonably correlated with the price dynamics
market – with unmatched transparency.
of the CDS Index futures.


Example: The buyer of CDS Index futures might • Exchange-for-Swap (EFS) trades, which
simultaneously sell a comparably scaled Treasury- are similar to EFP trades, except that the
Agency spread, by selling 10-year Treasury notes buyer of CDS Index futures enters into a
and buying 10-year Agency debentures. The seller comparably scaled OTC credit default swap as
of the CDS Index futures would take the other side the protection seller. Conversely, the seller of
of the cash transaction as buyer of the 10-year the CDS Index futures position takes the other
Treasuries and seller of the 10-year Agencies. side of the OTC credit default swap, as the
protection buyer.
Example: The CDS Index futures buyer might • Exchange-for-Risk (EFR) trades, which are
simultaneously sell a comparably sized exposure similar to EFS trades, except that the buyer of
in the Swap-Corporate yield spread, by buying CDS Index futures enters into an OTC option
corporate bonds and taking the fixed-payer side of position with a delta that is negatively related to
an OTC plain-vanilla swap. The seller of the CDS the level of credit default swap spreads. That is,
Index futures would take the other side of the cash he is either the purchaser of a put on protection
transaction, as the fixed-rate receiver on the plain- or the seller of a call on protection. Conversely,
vanilla interest rate swap and as the seller of the the seller of the CDS Index futures takes the
corporate bonds. other side of the OTC option transaction: She
is either the buyer of a call on protection or the
seller of a put on protection. The DV01 of the
CDS Index futures position is approximately
the same size as the delta of the OTC
option position.

The Chicago Board of Trade Rules and Regulations

are the authoritative source regarding permissible
off-exchange transactions. Regulation 331.05
covers wholesale trades. Regulation 331.08 governs
EFP, EFR, and EFS transactions. The Rules and
Regulations are found on the CBOT website at


The CDR Liquid 50 Index:

Composition and Structure
As noted earlier, the underlying reference for CBOT This pairing – December 2008 futures and the
CDS Index futures is the CDR Liquid 50 North America 084 index series -- would briefly coexist with the
Investment Grade Index, maintained and published by (hypothetical) September 2008 futures and the
Credit Derivatives Research LLC. corresponding 083 index series. Since the last
trading day in September 2008 futures would be
In broad overview, the index mechanism is delightfully Monday, 15 September, the overlap would be just
simple: an arithmetic average of standard 5-year under two weeks.
single-name credit default swap spreads, quoted on
each of the 50 corporate names represented in the The composition of the two index series, 083 and
index. Index components are selected on the basis of 084, may differ, but this would have no direct
their credit quality -- all must be issuers of investment bearing upon the expiry value of the September
grade debt – and on the basis of trading activity in the 2008 futures. The underlying reference for that
single-name credit default swaps that reference them. contract would be the 083 index series, and no
other. Similarly, the expiry value of December 2008
Index Series and Futures Expiries futures would rely solely upon the 084 index series,
and no other.
The CDR Liquid 50 index is reconstituted quarterly,
such that each index series corresponds to an
individual futures contract expiry. (For details, see Selection of Index Components
Sections 2 and 3 of Appendix 3.) For each new CDR Liquid 50 index series, the
50 components are selected from the universe
Example: Consider a hypothetical December 2008 of standard credit default swap spreads, where
CDS Index futures contract. Its underlying reference “standard” means any on-the-run credit default swap
would be the 084 series of the CDR Liquid 50 with 5 years to maturity, denominated in US dollars,
index (where 084 refers to the fourth, or December, referencing taxable bonds that are rated BBB/Baa2
quarter of 2008). Index components of the 084 or higher and that are issued by a North American
series would be chosen and published after close of corporation. (For details, see Sections 1, 4, and
business on the last business day of August (Friday, 5 of Appendix 3.)
29 August 2008). The next business day (Tuesday,
2 September) would be both the index roll date and
the first day of trading in December 2008 futures.


Sidenote: The rating standard requirement – index component DV01s. Each index component
Standard & Poor’s BBB and Moody’s Baa2 -- is DV01 is the dollar value of a 1 basis point change in
more stringent than the requirements that apply one of the single-name credit default swap spreads
to many other investment grade credit default serving as an index component, with the notional
swap indexes. For example, to be considered amount of the credit default swap assumed to be
for admission to the well-known CDX.NA.IG $1. The key inputs in computing this collection of
(the CDX North America investment grade parameters are the levels of credit default swap
credit default swap index) a credit default swap spreads for each of the 50 index components, and the
may reference securities rated anywhere within level of the 5-year plain-vanilla swap rate, at the time
the investment grade spectrum. (See “Index the index series is constituted.
Methodology for the CDX Indices”, 22 May 2007, This means that a debt issuer Using these 50 index component DV01s, CDR
rated as low as BBB-/Baa3 might be eligible LLC will then compute and publish various
to become a component of the CDX.NA.IG index parameters:
index, whereas the same debt issuer would be
automatically ruled out for inclusion in the CDR • the index DV01, the arithmetic average of the
Liquid 50 index. The index managers at CDR 50 index component DV01s. Like the index
LLC have incorporated this tighter definition of component DV01s, the index DV01 presumes
“investment grade” into their index design in a $1 notional amount.
order to lend stability to the index’s composition
• the notional size of the credit default swap
– i.e., to reduce the rate of turnover among index
exposure embodied in the corresponding CDS
components -- from one index series to another.
Index futures contract. This is equal to the
futures contract DV01, always $500 per basis
The CDR index managers then rank all elements of point, divided by the index DV01.
the universe by trading activity, measured in terms of
• the standard recovery rate that the index
frequency of actionable bid-offer quotes, during the
managers will employ in all subsequent index
three months preceding the index roll date. The more
calculations. The standard recovery rate may
quoting activity, the higher the rank. The quote data
vary from one CDR Liquid 50 index series to
that CDR LLC employs in determining this ranking are
another, depending upon what is deemed to be
furnished by CMA through its DataVision service. (For
market convention at the time the index series
a description of CMA DataVision and an overview of
is constituted. (The recovery rate that market
its framework for data collection and preparation, see
participants regard as customary has varied in
Appendix 4.) Broadly speaking, the 50 highest-ranked
recent years between 0.3 and 0.4, i.e., 30 to
elements of the universe become the components of
40 percent of notional.) Setting the standard
the new index series.
recovery rate is left to the sole discretion of
CDR LLC. Once the standard recovery rate
Maximum Running Spread and for an index series has been set, however, it
Other Index Parameters remains fixed for the life of that index series.
To assemble these components into a new index
series, the CDR index managers begin by computing


• Perhaps most important is the maximum Against this backdrop, the maximum running spread
running spread, which functions as an upper serves as a reasonable place-holder, enabling the
bound on the values that index components index managers to assign plausible values to all
may take. The maximum running spread is index components, and thus to publish a valid and
computed as1 methodologically consistent index value each day,
irrespective of discontinuities in market quote traffic.
Maximum Running Spread =
(1 – Standard Recovery Rate) / Index DV01.
Responsiveness. Imposing a structural limit upon
admissible values of index components enables the
For definitions and detailed explanations, see Section
index to rely solely upon market rates as inputs.
6 of Appendix 3.
Importantly, this means index evaluation requires no
arbitrary or ad hoc decisions, or speculation, on the
Imposing the maximum running spread as an upper
part of the index managers as to whether a credit
bound on index inputs might appear to be arbitrary.
event may have occurred or might be imminent.
In fact, it is not. It plays a natural role in ensuring the
Thus, paradoxically, the maximum running spread
stability, continuity, and responsiveness of the CDR
mechanism makes the CDR Liquid 50 index more
Liquid 50 index –
directly responsive to market rates, prices, and
Stability. Suppose a credit event overtakes, or
threatens to overtake, one of the 50 corporate entities
in the index. Market quotes on credit default swap
spreads referencing that entity are apt to widen,
possibly to extreme levels, relative to credit default
swap spreads for other index components. Capping
the index inputs at the maximum running spread
permits the distressed outlier to enter the index, while
simultaneously preventing it from exerting undue
“outlier” influence upon the index average.

Continuity. Whenever a corporate entity becomes

distressed, or threatens to become distressed, liquidity
commonly gets patchy in single-name credit default
swaps referencing that entity. Conversely, whenever
market quote activity dries up in single-name credit
default swaps for a given corporate debt issuer, the
likeliest explanation is market apprehension that the
issuer is under imminent threat of a credit event.

To appreciate the conceptual role of the maximum running spread, readers familiar with credit derivatives will want to recall the iron triangle of
credit default swap valuation:
Hazard Rate = Credit Default Swap Spread / ( 1 – Recovery Rate )
In this framework, the maximum running spread identifies the threshold at which the implied credit event hazard rate equals the basis point value
of a $1 change in the value of the index portfolio.


The CDR Liquid 50 Index:

Some Stylized Facts
Exhibit 2 shows daily readings of CDR Liquid 50 an elaborate dealer polling procedure in the case
index series from late March 2006 through early June of CDX.NA.IG – such behavioral differences are
2007. It juxtaposes them with daily values for the three unsurprising.
coeval series of the CDX.NA.IG, widely acknowledged
to be the benchmark in the US credit derivatives Exhibits 3 and 4 demonstrate these compositional
index arena. differences via comparison of on-the-run index series
as of June 2007 – specifically the CDR Liquid 50
The two time series plots obviously mimic each series 072, and the CDX.NA.IG Series 8 Version
other’s broad trends and low frequency swings. Just 1. At least three features of the comparison are
as clearly, however, they are far from identical. The worth pointing out. First, the CDR Liquid 50 index
correlation between their daily changes is a modest places notably more weight upon the Financial and
0.67. Given the differences in their index composition Communications & Technology sectors. Second, its
procedures – rule-based selection on the basis of emphasis upon the liquidity of its index constituents
trading activity in the case of CDR Liquid 50, versus leads it, in this example at least, to concentrate nearly

CDR 062 CDR 063 CDR 064 CDR 071 CDR 072 Exhibit 2
CDR Liquid 50 and CDX,
Daily, 21 March 2006 to
45 11 June 2007
Index Credit Spread (Bps)

Data Sources: CDR LLC, CMA,

Markit Group Ltd.

35 Notes: CDX.NA.IG index components

are as given by Markit Group Ltd.

CDX.NA.IG index values are

Index Credit Spread (Bps)
computed with single-name credit
default swap spread data furnished
by CMA.
































2-May-06 25-Jul-06
13-Jun-06 17-Oct-06 20-Feb-07
21-Mar-06 28-Nov-06 15-May-07


all of its sectoral exposure in just four sectors: Consumer Cyclicals and Noncyclicals, in addition to Financials and
Communication & Technology. Third, for the same reason, the CDR Liquid 50 index accords relatively little or no
weight to Industrials, Materials, Energy, Utilities, and Government (i.e., Fannie Mae and Freddie Mac).


28 Exhibit 3
CDX Sector Composition as
CDR Liquid 50 Percent of Index Weight:
CDR Liquid 50 versus CDX
(CDR Liquid 50 Series 072
and CDX.NA.IG Series 8
14 14
Version 1, Maturing 20
June 2012)

5 Data Sources: CDR LLC, Markit
Group Ltd
2 2 2 2

Financial Cons Comm + Cons Industrial Materials Utilities Energy Govt Other
Cyclical Tech Noncyclical

Among sectors that dominate the CDR Liquid 50 index make-up, the degree of overlap with corresponding
sectors in the CDX.NA.IG is generally high. For example, as Exhibit 4 shows, of 14 corporate names from the
Consumer Cyclicals sector that serve as CDR Liquid 50 index components, 11 also stand as CDX.NA.IG index
components. As a general rule, approximately three quarters of each sector’s weight in the CDR Liquid 50 index
signifies overlap with the CDX.NA.IG. The one glaring exception is the Financials sector.

C DR L iquid 50 NA I G
14 Exhibit 4
Sector T otals
CDR Liquid 50 NAIG Index, Series 072:
30 of 50 index components also appear in
Index Overlap Between
7 CDX.NA.IG expiring 20 June 2012 CDR Liquid 50 and
9 CDX: Numbers of Index
Overlap with C DX .NA .I G 4 5 1 1 Components
(CDR Liquid 50 Series 072
2 2
and CDX.NA.IG Series 8
6 Version 1, Maturing 20
17 8
15 11
June 2012)

23 Data Sources: CDR LLC, Markit
Sector T otals
Group Ltd

Cons Cynical

Comm + Tech

Cons Noncyclical







Govt Other
Utilities Energy
Financial Industrial Materials
Cons Cyclical
Comm + Tech
Cons Noncyclical


Financials: CDR Liquid 50 versus CDX The CDR Liquid 50 index is not so encumbered,
because its composition, maintenance, and data
The sharp divergence between the two indexes in their
sourcing are performed by neutral parties (namely
emphasis on Financials arises directly from the CDX.
CDR LLC and CMA). Insofar as its representation of
NA.IG index constitution procedures. The composition
the Financials sector is unconstrained, the CDR Liquid
of the CDX indexes is decided collectively by the
50 makes a potentially closer match for the sector
consortium of 16 credit derivative dealers who support
mix held by many corporate bond portfolio managers.
the CDX family. This roster includes ABN AMRO,
Exhibit 5 suggests as much, via comparison of the
Bank of America, Barclays Capital, Bear Stearns,
CDR Liquid 50 and CDX.NA.IG indexes with the
BNP Paribas, Citigroup, Credit Suisse First Boston,
Lehman Brothers US Corporate Index.
Deutsche Bank, Goldman Sachs, HSBC, JPMorgan,
Lehman Brothers, Merrill Lynch, Morgan Stanley, UBS,
and Wachovia. (Source: Markit Ltd.) Sidenote: A popular proverb in market folklore
holds that, for any index of credit default swap
Not only do these dealers decide CDX index spreads, the more weight the index accords
composition, they also serve as the main price-makers to Financials, the less volatile the index should
and liquidity-providers for the vast OTC derivatives be. The time series data portrayed in Exhibit 2,
market that has grown up around the CDX indexes. however, reveal just the opposite: The median
Potential conflict of interest considerations dictate that of absolute values of daily changes in the CDR
no consortium member should be eligible for inclusion Liquid 50 index is 0.44 basis points versus 0.38
as a CDX index component. Because the consortium basis points for the CDX.NA.IG index.
membership encompasses most of the leading issuers
of investment grade US financial corporate debt, this
means the CDX.NA.IG index is thus structurally tilted
toward under-representation of Financials.

Lehman US Corporate CDR Liquid 50 CDX

Exhibit 5
Sector Composition as
70 Percent of Index Weight:
Lehman Brothers US
Corp, CDR Liquid 50,
and CDX
43 (Lehman Brothers US
Corporate Index, 31 Dec
30 2006, CDR Liquid 50 Series
072, and CDX.NA.IG Series
8 Version 1)
10 Data Sources: CDR LLC, Lehman
2 Brothers Inc, Markit Group Ltd

Industrials Financial Utilities Govt


Synthetic Corporate
Bond Portfolios
By combining appropriate numbers of CBOT CDS Index futures with CBOT 5-Year IRS futures, an investor or
trader can assemble a futures position that mimics the price exposure of a generic portfolio of liquid investment
grade US corporate bonds. This synthetic portfolio is both simple and flexible in terms of the mechanics of futures
position management and pricing. The two component contracts cease trading on the same day and at the same
time. Both contracts expire by cash settlement. At contract expiry, the underlying references for both contracts
signify maturity exposure of 5 years.

Moreover, toggling back and forth between contract price exposure and implied yield exposure is unusually
straightforward. The 5-Year IRS futures contract is designed so that there is a one-to-one mapping from its price
to the implied forward-starting plain-vanilla swap rate2. CDS Index futures are priced with direct reference to a
forward-starting market-average 5-year credit default swap spread, quoted as a yield spread versus the 5-year
plain-vanilla swap rate. Thus, the implied forward-starting yield for the synthetic portfolio is the sum of (a) the
implied yield for 5-Year IRS futures and (b) the CDS Index futures price. Exhibit 6 shows the resultant implied
corporate bond portfolio yields, daily from late March 2006 to early June 2007, and how they compare with the
Moody’s Aaa Industrial/Utility average and the Moody’s Baa average.

CBOT Synthetic Corporate M oody's Aaa Ind&Utility M oody's Baa Exhibit 6

7 CBOT Synthetic Corporate

Bond Yields vs Moody’s
Aaa Industrial/Utility and
Baa Averages
Yield (Percent)

(CBOT synthetic corporate

bond yield equals (a) the
forward-starting swap
Yield (Percent)
rate implied by the nearby
5-Year IRS futures price
plus (b) the average credit
spread reflected in the CDR
5 Liquid 50 index.)











Data Sources: Board of Governors of

25-Jul-06 9-Jan-07 3-Apr-07 the Federal Reserve System, CBOT,
21-Mar-06 13-Jun-06 17-Oct-06
28-Nov-06 20-Feb-07 15-May-07

Translation from price to yield in CBOT IRS futures is facilitated by lookup tables furnished by the Exchange at


As the scatter plots in Exhibit 7 suggest, daily changes in the CBOT synthetic corporate bond yield are reasonably
well correlated with these market averages: 0.87 for the Moody’s Aaa Industrial/Utility, 0.89 for the Moody’s
Baa. By no means is either a perfect fit. But given the absence of any other exchange-listed contract or contract
spread that might be remotely suitable for hedging or replicating corporate bond exposure, the CBOT synthetic
portfolio makes an attractive and useful addition to any credit product trader’s risk-management toolkit.

Exhibit 7
Daily Changes in Moody’s Bond Yields (Bps)

Baa Corr = 0.89 Daily Yield Changes:

Aaa Corr = 0.87 CBOT Synthetic Corporate
10 Bond Portfolio, Moody’s
Aaa Industrial/Utility,
5 and Moody’s Baa
(21 March 2006 to
0 11 June 2007)

-5 Data Sources: Board of Governors of

the Federal Reserve System, CBOT,

Daily Changes in Moody's Bond Yields (Bps)
-20 -15 -10 -5 0 5 10 15 20
Daily Changes in CBOT Synthetic Bond Yield (Bps)


Long Corporates ≈ Long IRS Futures + Short CDS Index Futures

A few examples should make this concrete. To begin, consider a portfolio manager who anticipates buying
$1 billion of 5-year Aaa corporate bonds. Between now and when she actually acquires the bonds, she faces
two primary sources of yield risk:

changes in the 5-year benchmark yield (here, the 5-year plain-vanilla swap rate) and
changes in the corporate credit spread, the spread between the 5-year benchmark yield and 5-year corporate
bond yields.

To manage this exposure, she creates a synthetic place-holder portfolio by combining CBOT CDS Index futures
and 5-Year IRS futures. Properly structured, this should serve adequately both as an anticipatory hedge and as
a means of avoiding cash drag on the portfolio’s returns. If market conditions are as shown in Exhibit 8, then the
appropriate DV01-weighted hedge should consist of two components:

Long 9,798 5-Year IRS futures = $430,897/($43.98 per contract)

Short 862 CDS Index futures = $430,897/($500 per contract)

Exhibit 8
Market Conditions on Day 1
Price Yield DV01
5-Year Aaa Corporate Bonds $1 billion (par) 5.60 $430,897
CBOT 5-Year IRS Futures 102-19/32nds 5.401 $43.98/contract
CBOT CDS Index Futures 36.00 bps 0.36 $500/contract

Note that the long position in the synthetic portfolio comprises a long position in IRS futures (which references a
notional asset price) and a short position in CDS Index futures (which references a notional interest rate spread).

Now suppose market interest rates fall 50 bps, with credit spreads holding steady. Exhibit 9 summarizes the
change in market conditions.

Exhibit 9
Change in Market Conditions from Day 1 to Day 2
Day 1 Day 2
Price Yield Price Yield Price Change ($)
5-Year Aaa Corporates $1 billion (par) 5.60 $1,021,823,737 5.10 21,823,737
Long 9,798 5-Year IRS Futures 102-19/32nds 5.401 104-26.5/32nds 4.901 21,892,406
Short 862 CDS Index Futures 36.00 bps 0.36 36.00 bps 0.36 Zero


Bonds that would have cost $1 billion to purchase at par previously are now $21.8 million more expensive. The
anticipatory hedge has generated sufficient proceeds, however, for the portfolio manager to keep up with market
valuations. Specifically, the 50 bps drop in yields translates into a jump of 2 points and 7.5/32nds in the price of
5-Year IRS futures. The corresponding mark to market on that portion of the hedge structure is:

$21,892,406.25 = 71.5/32nds x $31.25 per 32nd per contract x 9,798 contracts

Now, suppose instead that benchmark market rates hold steady, but that investment grade corporate credit
spreads narrow by 5 bps. Exhibit 10 details the change in market conditions.

Exhibit 10
Change in Market Conditions from Day 1 to Day 2
Day 1 Day 2
Price Yield Price Yield Price Change ($)
5-Year Aaa Corporates $1 billion (par) 5.60 $1,002,157,249 5.55 2,157,249
Long 9,798 5-Year IRS Futures 102-19/32nds 5.40 102-19/32nds 5.40 Zero
Short 862 CDS Index Futures 36.00 bps 0.36 36.00 bps 0.31 2,155,000

As before, the rise in bond prices might compel the portfolio manager to chase after the market. Without the
protection afforded by her anticipatory hedge structure, she would find herself paying nearly $2.2 million more
for the same bonds today than she would have paid previously. However, the “protection seller” exposure to
corporate credit spreads that she established by selling CDS Index futures keeps her overall portfolio in synch
with market conditions. The mark to market on the CDS Index futures component of her hedge structure comes
reasonably close to matching the move in bond prices:

$2,155,000 = -5 bps x $500 per bp per contract x -862 contracts


Short Corporates ≈ Short IRS Futures + Long CDS Index Futures

The same strategy applies to more elaborate hedge structures. Thus, consider another portfolio manager who
intends to sell $1 billion of 8-year Baa corporate bonds. Rather than exiting the position abruptly, he decides to
hedge his exposure by selling a synthetic corporate bond portfolio consisting of CBOT futures.

Exhibit 11
Market Conditions on Day 1
Price Yield DV01
8-Year Aaa Corporate Bonds $1 billion (par) 6.50 $616,218
CBOT 5-Year IRS Futures 102-19/32nds 5.401 $43.98/contract
CBOT 10-Year IRS Futures 103-24.5/32nds 5.505 $77.88/contract
CBOT CDS Index Futures 36.00 bps 0.36 $500/contract

Assume market conditions are as in Exhibit 11. Because the portfolio manager is concerned about adverse
portfolio impacts from both increases in the outright level of benchmark yields and changes in the slope of
the yield curve, he decides to combine a short position in an IRS futures barbell with a long “protection buyer”
position in CDS Index futures. Using conventional DV01 weights to set the wings of his IRS futures barbell3, he
determines that the benchmark yield component of his hedge structure should consist of 48 percent 5-Year IRS
futures and 52 percent 10-Year IRS futures. Thus his hedge structure is:

Short 6,720 5-Year IRS futures

Short 4,118 10-Year IRS futures
Long 1,232 CDS Index futures = $616,218/($500 per contract)

As before, note the mix of long and short contract positions: The short synthetic portfolio comprises a
short position in the IRS futures barbell and a long position in CDS Index futures.

Now, suppose a sudden burst of buoyant economic conditions pushes the yield curve into inversion, with rising
short- and intermediate-term yields pivoting around unchanged long-term yields: 5-year swap rates increase 40
bps, 8-year swap rates gain 16 bps, and 10-year swap rates hold steady. Suppose moreover that corporate
credit spreads across the curve narrow by 5 basis points. The combined impact is an 11 bps rise in 8-year
corporate yields (16 bps increase in benchmark 8-year yields, minus 5 bps decline in credit spreads).
Exhibit 12 summarizes.

Let D10, D5, and D, respectively, represent DV01s for a 10-Year IRS futures contract, a 5-Year IRS futures contract, and $100,000 face
value of the cash 8-year corporate bonds, and note that a $1 billion par position in corporate bonds contains 10,000 units of $100,000 par value.
Then the 5-Year IRS futures wing of the butterfly is computed as
10,000 x (D/D5) x (D10 – D)/(D10 – D5)
The (D10 – D)/(D10 – D5) term, which plays the principal role in shaping the wing, takes the value of 0.48 in the example above.
Similarly, the 10-Year IRS futures wing of the butterfly is equal to
10,000 x (D/D10) x (D – D5)/(D10 – D5)
The (D – D5)/(D10 – D5) term, which shapes this wing, equals 0.52 in the example above.


Exhibit 12
Change in Market Conditions from Day 1 to Day 2
Day 1 Day 2
Price Yield Price Yield Price Change ($)
8-Year Baa Corporates $1 billion (par) 6.50 $993,249,765 6.61 -6,750,235
Short 6,720 5-Year IRS Futures 102-19/32nds 5.401 100-27.5/32nds 5.801 11,655,000
Short 4,118 10-Year IRS Futures 103-24.5/32nds 5.505 103-24.5/32nds 5.505 Zero
Long 1,232 CDS Index Futures 36.00 bps 0.36 31.00 bps 0.31 -3,080,000
Hedge Total 8,575,000

The updraft in short- and intermediate-term yields seriously would warn that such an imbalanced hedge
hands the portfolio manager a $6.8 million loss on his (in essence, the yield curve exposure between 5-year
core bond position. Fortunately, the hedge affords and 8-year swap rates) might just as easily hurt you as
more than enough protection, generating proceeds of help you.
nearly $8.6 million, for a net gain of $1.8 million.
Second, the CDS Index futures hedge ratios in
Three remarks warrant mention. The first is simply to the examples above are set on the rudimentary
note the relative accuracy that the portfolio manager assumption that the credit spread exposure in the
achieves by using an IRS futures barbell to hedge hedge target and the CDS Index futures price move
his benchmark interest rate exposure. If instead he in lockstep, basis point for basis point. Generally,
had used a DV01-equivalent number of 10-Year IRS this presumption would be unrealistic. A more
futures alone (7,912 contracts in this case), he would refined approach might incorporate the credit spread
have found himself underhedged and consequently analogue to stock index betas. That is, in setting the
nursing a $9.8 million net loss (comprising the $6.75 credit spread component of the hedge structure,
million loss on the core bond position and the $3.1 the portfolio manager might take explicit account of
million margin payout on the CDS Index futures systematic differences in volatility between the CDS
position). Index futures contract price and the hedge target’s
credit spread.
Had he used a DV01-equivalent number of 5-Year
IRS futures alone (here, 14,011 contracts), he would Third, at first blush, the sizes of the futures
have been lavishly overhedged. Gains on his hedge transactions in the examples above may appear
position would have exceeded triple the loss on his imprudently large. In fact, given that both IRS futures
core bond position ($21.2 million, comprising $24.3 and CDS Index futures are eligible for a wide array of
million margin collects on 5-Year IRS futures, less bilaterally negotiated off-exchange trades, including
$3.08 million in margin pays on CDS Index futures). block trades, such magnitudes are neither unrealistic
That’s a gratifying outcome, at least in this case, but nor infeasible. (See “Off-Exchange Trading” on pages
any market practitioner who takes risk management 9 and 10.)


Pricing CDS Index Futures:

Spot versus Forward
Each day CDR LLC publishes the spot value of the • The credit default spread – essentially the
CDR Liquid 50 index. As noted earlier, this is the price of the credit default swap itself -- which
average of on-the-run 5-year single-name credit dictates the amount, measured in basis points
default swap spreads quoted that day, for spot per annum, that the protection buyer pays to
settlement, for each of the 50 index components. In the protection seller to guarantee coverage of
contrast, the index value reflected in the price of the the portion of asset exposure not covered by
companion CBOT CDS Index contract is a forward the recovery rate.
value, the market expectation of the pertinent CDR
Liquid 50 index series on the contract’s last day of In a world where the yield curve is flat and the hazard
trading. rate is constant, these three elements form the well-
known iron triangle of credit default swap pricing:
Spot ≈ Forward, Generally
As with any other pair of spot and forward market Credit Default Spread =
rates or prices, these two will seldom be identical, (1 – Recovery Rate) x Hazard Rate
except when the futures contract expires. In practice,
however, the difference between spot and forward Example: Assume the representative “average”
typically will be negligible. To make this clear, consider member of the CDR Liquid 50 index features a
the three primary linkages in the pricing of a credit credit default swap spread of 39 basis points.
default swap: Assume as well a standard recovery rate of 40
percent and a hazard rate of 0.65 percent per year.
• The recovery rate, the percentage of face Then the iron triangle takes shape as: 39 bps =
value that a bond holder would expect to 0.0039 percent = ( 1 - 0.40 ) x 0.0065
recover from the bond issuer in the event
that the issuer defaults, enters bankruptcy, or Given the assumptions underpinning the iron triangle
suffers some other credit event that impairs – flat yield curve and flat survival function -- spot and
timely payments to his debt holders. forward-starting credit default swap spreads should be
• The hazard rate (or, when cumulated, identical. More generally, even though yield curves are
the survival function) which determines the seldom flat, and the hazard rate is seldom constant,
probability per unit of time that the bond issuer spot and forward-starting credit spread values will
will suffer a credit event. tend to be quite close, if not indistinguishable.


Exceptions Depend on the Hazard Rate

On those occasions when spot and forward do deviate significantly, the most likely cause is apt to be a non-
constant hazard rate. To see this, consider the pricing of 5-year protection on the CDR Liquid 50 index portfolio,
and assume the following hypothetical market conditions –

• Arbitrarily, “today” is 18 June 2003.

• Spot rates quoted “today” are for T+2 settlement on 20 June 2003. (In fact, this signifies standard
settlement for interest rate swaps, but “skip day” settlement for credit default swaps.)
• The LIBOR/plain-vanilla interest rate swap curve is flat at 5 percent
• The assumed standard recovery rate is 40 percent.
• For spot settlement, market participants value protection on the CDR Liquid 50 index portfolio at 100 bps
per annum.

If the hazard rate were constant, then given these market conditions, the iron triangle would imply a hazard rate of
1.666 percent for the representative “average” member of the index portfolio:

100 bps = 0.01 percent = ( 1 - 0.40 ) x 0.01666

Assume instead that market participants believe (a) that the average hazard rate will be zero over the coming year
-- reflecting perhaps the very strong presumption of a benign credit environment -- and (b) that the hazard rate
will run thereafter at a constant 2.156 percent per annum. The two far left-hand columns of Exhibit 13 summarize
this set-up.

The two main panels Exhibit 13 illustrate, on the left, the valuation of a hypothetical 5-year credit default swap for
spot settlement on 20 June 2003 and, on the right, the valuation of forward-starting 5-year credit default swap
that is constructed to mimic a hypothetical September 2003 CDS Index futures contract. The settlement date for
this hypothetical forward-starting swap is IMM Wednesday, 17 September 2003.

Valuation is elementary and, to market practitioners active in credit derivatives, quite familiar. The present value
of the swap’s premium leg (the stream of fixed protection payments weighted by the cumulative probability
that there is no credit event) must equal the present value of the swap’s recovery leg (the probability that the
protection seller will be obliged to pay the protection buyer if a credit event occurs):

Protection Leg Recovery Leg

Spread x ∑ [ai x zi x (1-pi)] = (1 – Recovery) x ∑ [zi x (pi -pi-1)]


“Spread” is the credit default swap spread, in interest rate percentage points per annum

“Recovery” is the recovery rate, assumed to be 40 percent, or 0.40

ai are daycount terms. Any ai represents the interval from payment date i-1 to payment date i, measured in
actual/360 terms, and it determines exactly how the credit default swap spread is apportioned to quarterly
protection payments.

zi are present value discount factors, bootstrapped from the plain-vanilla interest rate swap curve. Note that in
the left-hand panel of the table, these are spot discount factors, denoting present value as of the spot settlement
date (20 June 2003) of one dollar on date i. In the right-hand panel, they are forward discount factors, giving the
arbitrage-free present value as of the forward settlement date (17 September 2003) of one dollar on date i.

pi represent the survival function. Each pi signifies the probability that a credit event occurs prior to date i.

Exhibit 13
Spot versus Futures-Equivalent Forward Settlement: How the Hazard Function Matters
Spot Settlement on 20 Jun 2003 Forward Settlement on 17 Sep 2003

Premium Leg Protection Leg Premium Leg Protection Leg

Spot Spread Recovery Rate Spot Spread Recovery Rate
100 bps 0.4 107 bps 0.4

Spot Spot Forward Forward

Date p a z a *z*(1-pi) (1-0.4)*z*(pi - pi-1) a z a *z*(1-pi) (1-0.4)*z*(pi - pi-1)
17-Sep-03 0.9878
22-Sep-03 0.0000 0.26 0.9871 0.2577 0.0000 0.01 0.9993 0.0139 0.0000
22-Dec-03 0.0000 0.25 0.9749 0.2464 0.0000 0.25 0.9870 0.2495 0.0000
22-Mar-04 0.0000 0.25 0.9631 0.2434 0.0000 0.25 0.9750 0.2465 0.0000
21-Jun-04 0.0000 0.25 0.9517 0.2406 0.0000 0.25 0.9635 0.2435 0.0000
20-Sep-04 0.0054 0.25 0.9401 0.2363 0.0031 0.25 0.9517 0.2393 0.0031
20-Dec-04 0.0108 0.25 0.9286 0.2322 0.0030 0.25 0.9401 0.2351 0.0030
21-Mar-05 0.0162 0.25 0.9172 0.2281 0.0030 0.25 0.9286 0.2309 0.0030
20-Jun-05 0.0216 0.25 0.9060 0.2241 0.0029 0.25 0.9172 0.2268 0.0029
20-Sep-05 0.0269 0.26 0.8948 0.2225 0.0029 0.26 0.9058 0.2253 0.0029
20-Dec-05 0.0322 0.25 0.8839 0.2162 0.0028 0.25 0.8948 0.2189 0.0028
20-Mar-06 0.0374 0.25 0.8731 0.2101 0.0027 0.25 0.8839 0.2127 0.0028
20-Jun-06 0.0427 0.26 0.8623 0.2110 0.0027 0.26 0.8730 0.2136 0.0028
20-Sep-06 0.0480 0.26 0.8517 0.2072 0.0027 0.26 0.8622 0.2098 0.0027
20-Dec-06 0.0531 0.25 0.8413 0.2014 0.0026 0.25 0.8517 0.2038 0.0026
20-Mar-07 0.0582 0.25 0.8311 0.1957 0.0025 0.25 0.8413 0.1981 0.0026
20-Jun-07 0.0634 0.26 0.8208 0.1964 0.0025 0.26 0.8309 0.1989 0.0026
20-Sep-07 0.0686 0.26 0.8106 0.1930 0.0025 0.26 0.8206 0.1953 0.0025
20-Dec-07 0.0736 0.25 0.8007 0.1875 0.0024 0.25 0.8106 0.1898 0.0025
20-Mar-08 0.0786 0.25 0.7910 0.1842 0.0024 0.25 0.8007 0.1865 0.0024
20-Jun-08 0.0837 0.26 0.7812 0.1829 0.0024 0.26 0.7909 0.1852 0.0024
22-Sep-08 0.0888 0.26 0.7809 0.1858 0.0024


If one knew everything about the market landscape starting credit default swap should have higher fair
except the credit default spread itself, one could then value than for the spot swap. With the passage
use the framework above to solve for it4: of time, the two must converge, so that on 15
September 2003 they will be identical. That is, given
Spread = { (1 – Recovery) x ∑ [zi x (pi -pi-1)] } our maintained assumption of a T+2 timetable for
spot settlement, both the forward-starting swap and
∑ [ai x zi x (1-pi)]
a spot swap quoted on Monday, 15 September,
would be intended for settlement on Wednesday,
Exhibit 13 does precisely this. That is, to get the credit
17 September5. Moreover, if the other assumptions
default swap spread for spot settlement, in the left-
above regarding market conditions were to remain
hand panel of table one would divide the sum of the
static, then convergence would be achieved through
Protection Leg column by the sum of the Premium
a gradual increase in the spot spread, until it reaches
Leg column. Similarly, to obtain the forward-starting
107 bps on Monday, 15 September.
credit default swap spread, in the right-hand panel
one would divide the sum of the Protection Leg
Rolling Down the Curve
column by the sum of the Premium Leg column.
On occasion, market practitioners may observe
Unlike the spot spread, which is fairly valued at 100 discontinuities in the time series plots of spot values
bps, the forward-starting spread is fairly valued at 107 for individual CDR Liquid 50 index series. Such
bps. Intuitively, this is because the level of credit event discontinuities, when they occur, are apt to coincide
insurance furnished by the forward-starting swap is with the standard quarterly payment dates in the OTC
greater than the coverage provided by the spot swap: single-name credit default swap market (i.e., on or
just after the 20th of March, June, September, and
• Given the survival function’s shape, the 5-year December).
interval spanned by the spot credit default
swap comprises relatively more moments when Example: Consider the hypothetical credit default
the probability of a credit event is presumed to swap sketched in the main left-hand panel of Exhibit
be zero. 13. It corresponds to the hypothetical 032 series
of the CDR Liquid 50 index, which would have
• Conversely, the 5-year interval spanned by the
been constituted on Friday, 28 February 2003. (The
forward-starting credit default swap comprises
equally hypothetical companion CDS Index futures
relatively more moments when credit events
would have been the June 2003 contract, listed for
might occur.
trading on Monday, 3 March 2003.)

In short, the shape of the hazard rate function in this Between 3 March and 18 March, the on-the-run
example dictates that the spread for the forward- credit default swap spreads that CDR LLC uses

Students of the credit derivatives market will recognize that this computation incorporates not merely the assumption of a flat hazard rate
function, but also the assumption of a stationary copula scheme governing the manner in which credit events occurring among the 50 index
components might, or might not, occur in bunches.
This clarifies precisely how the forward-starting swap “corresponds” to the hypothetical September 2003 CDS Index futures contract: Monday,
15 September, would also be the last day of trading in futures.


to evaluate the index would be quoted for spot

settlement, with 5-year term to maturity extending
to 20 March 2008. That is, the index’s inputs would
be swap spreads with terms to maturity that are
actually close to 5 years.

By contrast, from 19 March through 16 June 2003

(the last day of trading in the June 2003 futures),
CDR LLC would evaluate the index components
with quotes for on-the-run spot-settled credit default
swaps that mature on 20 June 2008. Note that, at
the outset of this interval, the index’s inputs abruptly
become swap spreads with terms to maturity of
approximately 5.25 years.

Now suppose the hazard rate function is not

constant. That is, suppose the survival function is
either upward sloping or downward sloping. The
switch in data for index evaluation that occurs on
19 March -- from on-the-run quotes with 5 years
to maturity, to on-the-run quotes with 5.25 year to
maturity – may produce a corresponding break in
the time series of spot index values. Whether the
break is up or down, large or small, will depend
upon the slope and pitch of the term structure of
the survival function.

Users of CDS Index futures may note with relief that

there should be no such valuation “notch” in the daily
progression of futures prices, because fair valuation of
the futures contract is independent of the mechanics
of spot index valuation.

Thus, in the example above, market participants

would assess fair value in June 2003 CDS Index
futures on the presumption that, at contract expiry, the
underlying CDR Liquid 50 index would be evaluated
with market quote data for credit default swaps that
mature in June 2008. Moreover, they would knowingly
entertain this presumption throughout the entire
interval from first day of trading in June 2003 futures
until contract expiration.



Appendix 1
CDS Index Futures Contract Specifications
Underlying The corresponding series of the CDR Liquid 50TM North American Investment
Grade Index

Index Methodology Average of the five-year single-name credit default swap spreads of the 50 most
actively traded corporate names in the North American investment grade credit
default swap market. Initially all index components are equally weighted
(i.e., 2 percent index weight per component).

Contract Multiplier $500 per one basis point

Contract Value The index value in basis points multiplied by the contract multiplier

Price Quotation The index value in basis points and hundredths (1/100) of basis points. For example,
a futures price quotation of 38.10 implies an index value of 38.10 basis points.

Minimum Trading 1 tick = 0.01 basis points = $5


Expiration Months Generally, the nearest month in the March-June-September-December quarterly cycle

Last Trading Day The IMM Monday of the contract expiration month (i.e., the second London
business day preceding the third Wednesday of the contract expiration month)

Final Settlement Day The business day following the last trading day.

Final Settlement The index value, measured in basis points and hundredths (1/100) of basis points,
Price evaluated with single-name credit default swap spread quotes, as of close of
business on the last trading day, as furnished by CMA through CMA DataVisionTM

Settlement Cash settlement based on the final settlement price

Trading Hours 6:02 pm to 4 pm Chicago time, Sunday through Friday

Wholesale Trading Minimum wholesale transaction is 100 contracts. Permissible hours for wholesale
transactions are 7 am to 4 pm Chicago time, Monday through Friday. Consult for wholesale trading procedures.

Ticker Symbol CX


Appendix 2
CDS Index Futures Rules
For the current and authoritative version of the CBOT The designated index provider shall constitute and
Rulebook, visit the CBOT website at maintain a distinct CRI for each distinct CDS Index
futures contract month.

Chapter 61 CRI shall be an arithmetic average of interest rate

Credit Default Swap Index Futures credit default spreads, as reflected in prices of over-
the-counter credit default swap contracts with five (5)
years to expiry as of the CDS Index futures contract’s
last day of trading. Each interest rate credit default
Ch61 Trading Conditions swap spread that serves as a CRI component shall
6101.01 Authority - Trading in Credit Default Swap reference senior, unsecured, taxable, investment
Index futures may be conducted under such terms grade debt securities that are denominated in US
and conditions as may be prescribed by regulation. dollars and that are issued by a firm domiciled in
the US.
6102.01 Application of Regulations - Credit Default
Swap Index futures shall be referenced hereafter as 6105.01 Months Traded In - Trading in CDS
CDS Index futures. Transactions in CDS Index futures Index futures may be scheduled in such months as
shall be subject to the general rules of the Exchange determined by the Exchange.
as far as applicable and shall also be subject to
the regulations contained in this chapter, which 6106.01 Price Basis - The price of CDS Index futures
are exclusively applicable to trading in CDS Index contracts shall be quoted in interest rate basis points
futures. CDS Index futures are listed for trading by the and hundredths (1/100) of basis points. One basis
Exchange pursuant to Commodity Futures Trading point shall equal $500. The minimum price fluctuation
Commission exchange certification procedures. shall be one one-hundredth (1/100) of one basis point
($5 per contract). Contracts shall not be made on any
6104.01 Unit of Trading - The unit of trading shall be other price basis.
the Contract Reference Index. The Contract Reference
Index shall be referenced hereafter as CRI. CRI shall
be constituted and maintained by the Exchange’s
designated index provider.


6107.01 Hours of Trading - The hours of trading 6142.01 Delivery on Futures Contracts - Delivery
in CDS Index futures shall be determined by the against expiring CDS Index futures shall be made
Exchange. Trading in an expiring CDS Index futures by cash settlement through the Clearing Services
contract shall cease at 4:00 pm Chicago time on the Provider following normal variation margin procedures.
last day of trading in said futures contract.
The final settlement price shall be $500 times the
6109.01 Last Day of Trading - The last day of final settlement value of the CRI for the Last Day of
trading day in a CDS Index futures contract shall be Trading, as furnished by the Exchange’s designated
the second London business day before the third index provider.
Wednesday of the contract’s delivery month.
The final settlement price for an expiring CDS Index
6109.02 Liquidation During the Delivery Month futures contract shall be determined on the business
- After trading has ceased in expiring contracts (in day following the Last Day of Trading. For exceptions
accordance with Regulation 6109.01 of this chapter), to this schedule, see Regulation 6136.01.
outstanding contracts shall be liquidated by cash
settlement as prescribed in Regulation 6142.01. 6147.01 Payment - (See Regulation 1049.04.)

6110.01 Margin Requirements - (See Regulation


6112.01 Position Limits and Reportable Positions

- (See Regulation 425.01 and Appendix 4C.)

Ch61 Delivery Procedures

6136.01 Standards - The contract grade shall be the
final settlement value of the Unit of Trading (as defined
in Regulation 6104.01) for the Last Day of Trading
(as defined in Regulation 6109.01), as determined
and furnished to the Exchange by the Exchange’s
designated index provider. The value of the CRI
shall be represented in interest rate basis points and
hundredths (1/100) of basis points.

If the Exchange’s designated index provider fails to

report a value for the CRI for the Last Day of Trading,
then the contract final settlement price shall be based
upon the value of the CRI for the first preceding US
business day for which a value has been reported by
the Exchange’s designated index provider.


Appendix 3

CDR Liquid 50 NAIG Index Construction and


Maintenance Procedures
The CDR Liquid 50 North America Investment Grade 4. Eligibility Criteria for Index
Index (“the Index”) is an arithmetic average of 5-year Components
credit default swap (CDS) spreads for the 50 most 4.1 Eligibility Evaluation Period: The three-month
actively traded names in the North American CDS interval immediately preceding the Roll Date.
4.2 Data Universe: Actionable bid-offers on five-
year CDS spreads delivered by dealers directly
1. Index Components to their customers or to inter-dealer brokers
Index components are based upon CDS during the Eligibility Evaluation Period.
spreads with the following characteristics --
4.3 Credit Rating Filter: Reference securities
1.1 CDS reference securities: Taxable bond issues must be rated BBB/Baa2 or higher by two of
of North American corporations the three primary US Nationally Recognized
1.2 Priority of CDS reference securities: Senior, Statistical Rating Organizations throughout the
unsecured Eligibility Evaluation Period.
1.3 Maturity of CDS contracts: Five years 5. Selection of Index Components
1.4 Type of restructuring of CDS contracts: The following procedure will govern the
Modified restructuring selection of Index Components for any
reconstitution of the Index.
1.5 Currency denomination of CDS contracts: US
dollar 5.1 Names that satisfy the Eligibility Criteria for
Index Components, given in Section 4, will form
2. Index Roll Dates the pool of eligible names (the “eligible pool”).
First business day of March, June, September,
5.2 For each business day during the Eligibility
or December
Evaluation Period (4.1), for each eligible name,
3. Index Roll Procedures compute the number of actionable bid-offer
The Index will be reconstituted each quarter. quotes (4.2).
The components of each new constitution 5.3 For each business day during the Eligibility
of the Index, as well as various Index Evaluation Period (4.1), rank all eligible names
characteristics (6.1), will be publicly announced in descending order according to each name’s
following close of business on the business number of actionable bid-offer quotes (5.2).
day preceding the Roll Date (i.e., on the last
business day of the month preceding the
month of the Roll Date).


5.4 Compute the top-50 count for each eligible 5.9 Of the remaining names in the eligible pool,
name. For any eligible name, the top-50 count those names that appear as members in the
is defined as the number of days during the previous Index constitution shall be admitted
Eligibility Evaluation Period (4.1) on which that as Index Components in the new Index
name appears among the 50 highest-ranked constitution, in descending order of their top-
eligible names, as determined in 5.3. 50 counts. If and when 50 Index Components
have been identified, then the new Index
5.5 Rank all eligible names in descending order
constitution is complete. Proceed to Section 6.
according to their top-50 counts (5.4).
If fewer than 50 Index Components have been
5.6 Eligible names that share a parent corporate
identified, then proceed to 5.10.
entity (“sibling names”) are filtered from the
ranking determined in 5.5 as follows: 5.10 Admit remaining names in the eligible pool
as Index Components in the new Index
5.6.1 If an eligible name serves as an Index
constitution, in descending order of their top-50
Component in the previous Index constitution,
counts, until 50 Index Components have been
it will remain in the eligible pool for the new
Index constitution, and all of its other sibling
names will be eliminated from the eligible pool.
6. Index Calculation
5.6.2 If, within a group of sibling names, none
6.1 At the time a new Index is constituted, the
appears as an Index Component in the
following Index characteristics and parameters
previous Index constitution, then the sibling
shall be published:
name with the highest top-50 count within said
group of sibling names will remain in the eligible 6.1.1 Standard Recovery Rate: A parameter
pool for the new Index constitution, and all of with value between zero and unity that
the other sibling names in said group will be is set arbitrarily by the Index manager,
eliminated from the eligible pool. at his sole discretion, at the time of each
Index constitution, and shall be used in the
5.6.3 If, within a group of sibling names, more
calculation of all other Index characteristics
than one appears as an Index Component
pertaining to the new Index constitution. The
in the previous Index constitution, then the
Index manager, at his sole discretion, may
Component sibling name with the highest
change the value of the Standard Recovery
top-50 count among said Component sibling
Rate from one Index reconstitution to the next,
names will remain in the eligible pool for the
in accord with changes in prevailing market
new Index constitution, and all of the other
practice and/or market conditions.
Component sibling names will be eliminated
from the eligible pool. For any given Index constitution, the value of
the Standard Recovery Rate that the Index
5.7 If the resultant eligible pool has fewer than
manager sets shall (a) remain fixed throughout
60 names, then proceed directly to 5.8. If the
the lifespan of that Index constitution and
resultant eligible pool has 60 or more eligible
(b) serve as the only value of the Standard
names, then reduce it to those 60 names with
Recovery Rate that the Index manager employs
the highest top-50 counts, as determined in
in maintaining that Index constitution.
5.5 and 5.6.
5.8 Of the remaining names in the eligible pool, the
40 names with the highest top-50 counts shall
be automatically selected for inclusion as Index
Components in the new Index constitution.


6.1.2 Index DV01: The arithmetic average of Index Component DV01s, based on $1 notional. The Index DV01
will be computed using the following approximation for Index Component DV01s:
1 50
Index DV01 = ∑ Index Component DV01i
50 i =1
1 1 − exp(− (r + λi )* T )
Index Component DV01i =
10,000 (r + λi )
T = 5 years
r = 5 - Year US Dollar Plain - Vanilla Swap Rate
On - the - Run 5 - Year CDS Spread for Index Component i
λi =
1 - Standard Recovery Rate
The Index DV01 and all Index Component DV01s shall be rounded to seven decimal places, with half
increments in the eighth decimal place rounded up. Example: Assume that the 5-year plain-vanilla swap rate is 5 percent, that the on-the-run CDS spread
for the ith Index Component is 65 basis points, and that the Standard Recovery Rate has been set at 40
percent. Then:
λi = = 0.010833
1 - 0.4
1 1 − exp(− (0.05 + 0.010833)* 5)
Index Component DV01i = = 0.0004311
10,000 (0.05 + 0.010833)
6.1.3 Contract Value of a Basis Point: The dollar value of a one basis point change in the price of a CBOT CDS
Index futures contract. Note that this remains constant from one Index Construction date to the next. The
Contract Value of a Basis Point should not be confused with the Index DV01.
Tick Value $5
Contract Value of a Basis Point = = = $500 /bp
Tick Size 0.01bp

6.1.4 Implied CDS Notional: The notional underlying value of the CBOT CDS Index futures contract implied jointly
by the Index DV01 and the Contract Value of a Basis Point. The Implied CDS Notional shall be rounded to
the nearest dollar, with half-dollars rounded up to the nearest dollar:

Contract Value of a Basis Point

Implied CDS Notional = × $1
Index DV01 Example, contd: Assume the Index DV01 is $0.0004311/bp. By definition the Contract Value of a Basis
Point is $500/bp. Then:
Implied CDS Notional = × $1 = $1,159,824

6.1.5 Maximum Running Spread: The maximum admissible value for any Index Component, through the life of
the Index. The Maximum Running Spread shall be established at the time of Index constitution as:


Maximum Running Spread =

(1 − Standard Recovery Rate )* Implied CDS Notional

Contract Value of a Basis Point

The Maximum Running Spread shall be rounded to the nearest one one-hundredth (1/100) of one basis
point, with half-hundredths rounded up to the nearest hundredth of one basis point.
In any subsequent computation of the Index Value (6.4), any Index Component that exceeds the Maximum
Running Spread shall be replaced by the Maximum Running Spread. Example, contd: Assume as in that the Standard Recovery Rate is 40 percent and that the Implied
CDS Notional is $1,159,824. Then the Maximum Running Spread will be:
(1 − 0.4) * $1,159,824
Maximum Running Spread = = 1391.79 bps

6.2 Index Component Weight: At the time of Index constitution, each Index Component shall be assigned
index weight of one fiftieth (1/50), i.e., a 0.02 share of the Index composition.
6.3 Index Component Spread: The value that the Index manager assigns to each individual Index Component
in computing the Index Value (6.4). The Index Component Spread will depend upon whether single-name
CDS contracts that reference the corresponding Index Component name trade running or trade upfront.
An Index Component shall be identified, at the sole discretion of the Index manager, as to whether it
trades upfront or trades running, according to the conventions by which bid-offer prices are quoted for the
corresponding single-name CDS contracts.
6.3.1 Index Components that trade running: For any Index Component that trades running, the midpoint of
each bid-offer quote for the corresponding CDS will be used in computing the Index Value, subject to the
constraint that the Index Component Spread must be less than or equal to the Maximum Running Spread
6.3.2 Index Components that trade upfront: For any Index Component that trades upfront, the sum of the
running spread and the converted upfront percentage will be used in computing the Index Value, subject
to the constraint that the Index Component Spread must be less than or equal to the Maximum Running
Spread (6.1.5). The upfront percentage will be converted to an equivalent spread by multiplying the upfront
percentage by the Implied CDS Notional and dividing by the Contract Value of a Basis Point. Example, contd: Assume that the Implied CDS Notional is $1,159,824, and that the Maximum Running
Spread is 1,391.79 bps. Assume further that a particular Index Component trades at 18 percent upfront,
500 bps running. Then the provisional estimate of the corresponding Index Component is:
0.18 * $1,159,824
Component Spread = 500bps + = 917.54 bps

Because this provisional estimate is less than the Maximum Running Spread, the Index Component value
shall be set at 917.54 bps.
6.3.3 Index Components that have ceased to trade: For any Index Component that ceases to trade, in the sense
that actionable bid and offer prices cease to be quoted for the corresponding CDS contracts, the Index
Component Spread shall be set at the Maximum Running Spread.
6.3.4 Each Index Component Spread shall be rounded to the nearest one one-hundredth (1/100) of one basis
point, with half-hundredths rounded up to the nearest hundredth of one basis point.


6.4 Index Value: The Index Value is the sum of the products of each Index Component Weight (6.2) and its
corresponding Index Component Spread (6.3):
Index Value = ∑ Index Component Weight i × Index Component Spread i
i =1

N is the number of Index Components. At the time of Index constitution, N equals 50, and each Index
Component Weight is 0.02.
The Index Value, so computed, shall be rounded to the nearest one one-hundredth (1/100) of one basis
point, with half-hundredths rounded up to the nearest hundredth of one basis point.

7. Treatment of Succession Events Following Index Constitution

7.1 If, subsequent to an Index constitution, the corporate debt issuer referenced by a given Index Component
is superseded by successor corporate entities, then the original Index Component shall be removed from
the Index, and the successors shall be added as Index Components, regardless of the credit ratings (4.3)
that pertain to them. The Index Component Weights assigned to the successors shall sum to the Index
Component Weight that applied to the original Index Component that the successors shall supersede.
7.2 The Index Component Weight that shall be assigned to each successor shall be set equal to the product
of (a) the Index Component Weight that applied to the original Index Component, prior to the succession
event, and (b) the percentage share of the notional amount of the original single-name CDS that is
assigned to each successor. The Index Component Weights that shall be assigned to the successors shall
be calculated to six decimal places, with half increments in the seventh decimal place rounded up.
7.2.1 Example: Assume Alltel Corp (AT) is an Index Component. On 17 July 2006 Alltel Corp (AT) spins off
Windstream Corp (WIN). Each successor (AT and WIN) is assigned half of the notional value of single-
name CDS contracts that referenced the original Index Component (AT). In accommodating this
succession event, the Index manager makes the following modifications to the Index: the number of Index
Components rises from 50 to 51; the Index Component Weight that had been assigned to AT is reduced
from 0.02 to 0.01; and WIN is added as an Index Component with an Index Component Weight of 0.01.
7.3 In the event that the Index Component Weights assigned to the successors, so calculated, fail to sum
to the Index weight that applies to the original Index Component, then the successors shall be sorted
alphabetically by name, and the weight of the alphabetical first successor shall be adjusted so that the
successors’ Index Component Index weights sum to the Index Component Weight that applied to the
original Index Component.
7.3.1 Example: Assume that XYZ Corp is an Index Component, with an Index Component Weight of 0.02.
Assume, moreover, that it has been determined that XYZ Corp will be succeeded by ABC Corp, DEF
Corp, and GHI Corp. The Index manager accommodates this succession event by making the following
modifications to the Index: The number of Index Components rises from 50 to 52; XYZ Corp is removed
from the Index; ABC Corp is added as an Index Component with Index Component Weight of 0.006666;
DEF Corp and GHI Corp are each added as Index Components with Index Component Weights of
0.006667 each. Note that the sum of the successor Index Component Weights (0.00666 + 0.006667
+0.006667) is identically equal to the Index Component Weight (0.02) that had applied to the original
Index Component.


Appendix 4
CDS and CMA DataVision
Credit Market Analysis Ltd (CMA) is a credit Consortium. Thus, they provide a market consensus
information specialist that pioneers ways to increase view of market prices. CDS spreads, updated daily on
the efficiency of OTC credit market professionals. the basis of real-time indicative quotes, are combined
Founded in 2001 by credit market practitioners, CMA with bond prices, terms and conditions, and ratings
( is a privately held company data from the most respected sources in the market.
headquartered in London, with offices in New York. This enables CMA to calculate credit term structures
even for less liquid entities with a proprietary issuer/
CMA organizes CDS and bond quotes and valuation sector curve model.
data. CMA’s product lines include QuoteVisionTM,
the market’s leading real-time price discovery DataVision prices are based upon mid-market
service, and DataVisionTM, which furnishes same-day, prices, computed from actionable quotes on bid/
consensus-based price verification and price data. offer spreads, collected from a consortium of
CMA’s products and services are used by investment data contributors. CMA DataVision’s consortium
professionals at more than 150 leading investment of data contributors currently numbers 30 buy-
banks, hedge funds, and asset managers worldwide side institutions, located in the US, London, or in
to improve trading performance and to provide continental Europe. Membership in the consortium is
valuable information, not only for the front office but guarded by anonymity.
also risk, finance, and research groups.
On any given day, for any individual CDS product
CMA DataVision (single-name CDS, index, or tranche):
CMA DataVision provides price information for credit
default swaps (CDS), CDS indices, and CDS index • DataVision requires a quorum of valid data
tranches. DataVision price information spans the full submissions from at least 3 consortium
maturity structure of CDS and CDS products for all members before it will apply its pricing process
entities. New price data are available for same-day to the CDS entity.
delivery, both 5pm London time and 5pm New York • To be considered “valid” for that day’s
time. Additionally, DataVision maintains a data history DataVision pricing process, a consortium
archive. member’s price submission, in the form of
a mid-market average, must be based on
DataVision is available to more than 260,000 users bid/offer quotes from at least 3 separate
around the world via the Bloomberg Professional® independent sources.
service, from CMA directly, or via other third parties. • CMA then creates CDS pricing curves based
on spread observations for the CDS entity by
A Consensus-Based Pricing Service averaging all valid submissions.
DataVision prices are based on aggregated, averaged,
observed prices contributed by the CMA Data


To ensure integrity of these mid-market spread observed at each tenor on every day. To provide the
observations, CMA applies several error checks and best possible evaluation of less liquid entities, CMA
filters. The data validation process includes feeding has developed a sophisticated multi-step modeling
the spread observations into a proprietary CDS process, in conjunction with several clients and a team
term structure model. The empirical term structures of industry experts, to enable CMA to derive price
generated from this model are then used to test for points and to generate a full term structure with a high
and to identify anomalies. degree of accuracy. Using this process, CMA has
more than doubled the number of data points that can
The OTC nature of the credit market means that, for be confidently provided by DataVision.
any given entity, tradable price levels might not be


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“CDR”, Credit Derivatives Research,, CDR Liquid, CDR Liquid Global, CDR Liquid 50 North America Investment Grade, CDR Liquid 50 North America
High Yield, CDR Liquid 50 Europe Investment Grade, CDR Liquid 40 Europe High Yield, and CDR Liquid 50 Asia are service marks of Credit Derivatives Research LLC
(“CDR”) and have been licensed for use for certain purposes by the CBOT. The CBOT Credit Default Swap Index futures are not sponsored, endorsed, or sold by CDR,
and CDR makes no representation regarding the advisability of investing in such product(s).

“CMA DataVision” is a service mark of Credit Market Analysis (“CMA”) and has been licensed for use for certain purposes by the CBOT. The CBOT Credit Default Swap
Index futures are not sponsored, endorsed, or sold by CMA, and CMA makes no representation regarding the advisability of investing in such product(s).

The information in this publication is taken from sources believed to be reliable. However, it is intended for purposes of information and education only and is not
guaranteed by the Chicago Board of Trade as to accuracy, completeness, or any trading results, and does not constitute trading advice or constitute a solicitation for
the purchase or sale of any futures or options. The Rules and Regulations of the Chicago Board of Trade should be consulted as the authoritative source on all current
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© 2007 Board of Trade of the City of Chicago, Inc. All rights reserved.

CDR Liquid 50 NAIG Index Construction and Maintenance Procedures © 2007 Credit Derivatives Research LLC. All Rights Reserved.