3/22/16 Credit Risk (CDS Indices) | Japan Exchange Group

Credit Risk (CDS Indices)

Ma rkit iTra xx Ja pa n for About Ma rkit iTra xx A Guide to Cre dit Risk
Toda y Ja pa n Tra ding

How do I trade credit risk?

Cre dit risk is most broa dly de fine d a s the risk of a de btor not be ing a ble to me e t
its obliga tions. De bt gua ra nte e s or de fa ult insura nc e s ha ve be e n he dging tools for
c orpora te c re dit risk. A Cre dit De fa ult Swa p (CDS) is globa lly sta nda rdiz e d me a ns
of tra nsfe rring c re dit risk be twe e n two pa rtie s.

About CDS Trading

CDSs a re tra de d ove r-the -c ounte r (OTC) ma inly be twe e n fina nc ia l institutions.
Unde r a CDS tra de , the pa rty whic h wa nts to short c re dit risk (re fe rre d he re a fte r
a s "Prote c tion Buye r") ma ke s fixe d pe riodic pa yme nts (re fe rre d he re a fte r a s
"Fixe d Coupon"), while the pa rty who ta ke s the risk (re fe rre d he re a fte r a s
"Prote c tion Se lle r" ) re c e ive s the c oupon. In c a se of c e rta in c orpora te e ve nts
inc luding ba nkruptc y, fa ilure to pa y, a nd de bt re struc turing (re fe rre d he re a fte r
"Cre dit Eve nt") re c ogniz e d by third pa rtie s, the a ffe c te d CDS c ontra c t is se ttle d
be twe e n the two pa rtie s. If a Cre dit Eve nt doe s not oc c ur during the te rm, the
CDS c ontra c t te rmina te s without a ny othe r c a sh flow othe r tha n fixe d c oupon
pa yme nts ma de from Prote c tion Buye r to the Prote c tion Se lle r. Afte r Cre dit Eve nt
ha s oc c urre d, the se ttle me nt pric e is ge ne ra lly de te rmine d in a n a uc tion orga niz e d
by Inte rna tiona l Swa ps a nd De riva tive s Assoc ia tion, Inc . (ISDA). The a uc tion
re sults a dministra te d by Cre dite x a nd Ma rkit, a nd is publishe d on the following
we bsite :

Auc tion Re sults (Ma rkit a nd Cre dite x)

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About Credit Index Trading

General Information on Credit Index Trading

Cre dit inde x tra ding is simila r to bond tra ding in tha t the c oupon a nd ma turity a re
fixe d be fore the roll. For c re dit indic e s, pa yme nts from the Prote c tion Buye r to

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Prote c tion Se lle r a re ma de on a qua rte rly ba sis (re fe rre d he re a fte r a s "Fixe d
Coupon"). The ra te of the Fixe d Coupon is de te rmine d for e a c h inde x be fore the
roll a nd re ma ins sa me until the ma turity (For e xa mple , the c oupon for the Ma rkit
iTra xx Ja pa n Se rie s 20inde x is 100bps). Upfront pa yme nts a re ma de a t initia tion
be twe e n the Prote c tion Buye r a nd Se lle r, a nd c lose of the tra de to re fle c t the
c ha nge in spre a ds. The pric e (re fe rre d he re a fte r a s "Inde x Pric e ") is pa r minus the
pre se nt va lue of the spre a d diffe re nc e s. (Ple a se se e the tra ding e xa mple be low for
more de ta ils. ) Ma rke t pa rtic ipa nts use c a lc ula tion tools provide d by e xte rna l
ve ndors to c a lc ula te Inde x Pric e . Ma rkit a lso offe rs a fre e c a lc ula tion tool for CDS
indic e s tra ding whic h c a n be a c c e sse d from the link be low.

Ca lc ula tion Tool Inquiry (Ma rkit)

Example of CDS Indices Trading

H e re is a n e xa mple of how CDS Indic e s a re a c tua lly tra de d in the ma rke t.

Ove r the pe riod of the c ontra c t in whic h Prote c tion Buye r A buys the prote c tion
from Prote c tion Se lle r B, the re a re thre e kinds of c a sh flows i. e . upfront pa yme nt,
c oupon pa yme nts a nd se ttle me nt pa yme nt. The se que nc e of da te s for the tra de is
brie fly summa riz e d a s follows:

1. Inde x Roll Da te : On 21Se p2010(20se p2010 is a na tiona l holida y) the

c re dit inde x la unc he s with a pric e of 100%, 5 ye a r te rm a nd a fixe d
c oupon of 100bps.

2. Tra de Sta rt Da te : On 30N ov2010 Prote c tion Buye r A buys JPY 100 Million
notiona l prote c tion on the inde x whe n the spre a d ha s move d to 110bps.

3. Tra de Se ttle me nt Da te : 03De c 2010 (=Tra de Da te + 3 busine ss da ys)

4. Fixe d Coupon Move me nt: On 20De c 2010 Prote c tion Buye r A pa ys

Prote c tion Se lle r B the fixe d c oupon.

5. Tra de Te rmina tion Da te : On 14Ma r2011 Prote c tion Buye r A c lose s the
tra de whe n the spre a d goe s up to 130 bps.

6. Tra de Se ttle me nt Da te : 17Ma r2011 (=Tra de Te rmina tion Da te + 3

busine ss da ys)

1-3: Start-up Trade: "Upfront" and "Accrued Interest" payments

The Prote c tion Buye r A pa ys the Prote c tion Se lle r B a n Upfront (pa r minus the
pre se nt va lue of the spre a d diffe re nc e s) a nd Ac c rue d Inte re st Diffe re nc e s to tra de
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c re dit indic e s. In this e xa mple whe re the inde x spre a d is 110bps on the tra de
da te , the pric e is 99. 52 % (c a lc ula te d by the pric e c a lc ula tion tool offe re d by
Ma rkit). The pa yme nts a re c a lc ula te d a s follows a nd a re ma de thre e busine ss da ys
a fte r the tra de d da te .

Upfront = N otiona l * (the inde x pric e a t the inde x la unc h da te (100%) minus the
one a t the tra de d da te (99. 52%)) = JPY 100 Million * (100-99. 52) = JPY
480, 000.

Ple a se note tha t if the inde x pric e is ove r pa r (The fixe d c oupon is ove r the spre a d
on the tra de d da te ), the Prote c tion Se lle r pa ys the Prote c tion Buye r for the
diffe re nc e . In this e xa mple in whic h the pric e is le ss tha n 100% (the fixe d c oupon
is le ss tha n the inde x spre a d a t the tra de d da te ), the Prote c tion Buye r A pa ys the
Prote c tion Se lle r B for the pric e diffe re nc e .

Ac c rue d Inte re st = a c tua l da ys (from the pre vious c oupon pa yme nt da te or the
inde x la unc h da te to the tra de da te ) /360 * N otiona l * the Fixe d Coupon =
70/360 * JPY 100 Million * 0. 01 = JPY 194, 444. The Prote c tion Buye r A re c e ive s
a c c rue d inte re st a c c umula te d from the pa yme nt c oupon pa yme nt to the tra de
da te . Ple a se note tha t the Fixe d Coupon a c c rue s on a Ac tua l/360 ba sis.

In short, the Prote c tion Buye r A pa ys Prote c tion Se lle r B for the diffe re nc e of the
pa yme nts a bove , JPY 285, 556 (=JPY 480, 000- JPY 194, 444).

4: Quarterly Fixed Coupon Payments

Fixe d Coupon = N otiona l * Fixe d Coupon *90/360= JPY 100 M * 0. 01*90/360 =

JPY 250, 000 The Prote c tion Buye r A pa ys the Prote c tion Se lle r B the fixe d c oupon.
Ple a se note tha t c oupon(N umbe r of the da ys until pa yme nt , 90 for e xa mple , /360)
is pa id pe riodic a lly(qua rte rly). Ple a se note tha t the fixe d c oupons a re qua rte rly
ma de on 20Ma r, 20Jun, 20Se p a nd 20De c . If the pa yme nt da te fa lls on a holida y
or a we e ke nd, the pa yme nt is ma de on the following busine ss da y.

5-6: Trade Termination

Assume tha t Prote c tion Buye r A unwinds the tra de by se lling prote c tion. On the
te rmina tion da te whe n the spre a d is 130bps a nd the e quiva le nt pric e is 98. 63%,
the Prote c tion Buye r A pa ys the a c c rue d inte re st a c c umula te d up to the tra de
te rmina tion da te a nd re c e ive s the Inde x Pric e diffe re nc e (the Inde x Pric e a t the
la unc h da te (100%) minus the one a t the tra de d da te (98. 63%)).
The Inde x Pric e Diffe re nc e = JPY 100 Million * (100-98. 63)/100 = JPY 1, 370, 000.
The Ac c rue d Inte re st = JPY 100 Million * 0. 01 * 84/360 = JPY 233, 333.
The Prote c tion Buye r re c e ive s the diffe re nc e in the pa yme nts a bove , JPY
1, 136, 667 (=JPY 1, 370, 000-JPY 233, 333).

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3/22/16 Credit Risk (CDS Indices) | Japan Exchange Group

[Prote c tion [Prote c tion [Prote c tion

Da te Eve nt Buye r A]Ca sh Buye r A]Ca sh Buye r A]N e t
Inflow (+ ) outflow (-) Ca sh flow

Se p.
Inde x Roll Da te ,
21, - - -
Fixe d c oupon: 100bps
2010

Prote c tion Buye r A

N ov.
buys JPY 100 M
30, - - -
notiona l prote c tion on
2010
the inde x.

De c . The se ttle me nt da te Ac c rue d

Upfront
3, for the tra de e nte re d Inte re st JPY -285, 556
JPY 480, 000
2010 on 30N ov2010. JPY194, 444

De c . Coupon
20, Coupon Pa yme nt - Pa yme nt JPY -250, 000
2010 JPY 250, 000

Prote c tion Buye r A

Ma r.
unwinds the tra de
14, - - -
whe n the spre a d is
2011
130bps.

Inde x Pric e
Ma r. The se ttle me nt da te Ac c rue d
Diffe re nc e JPY
17, for the unwind tra de Inte re st
JPY 1, 136, 667
2011 done of 14Ma r2011. JPY 233, 333
1, 370, 000

JPY
Tota l Ca sh Flow JPY 963, 333 JPY 601, 111
1, 564, 444

Credit Event in Constituents of Credit Indices

Whe n a Cre dit Eve nt oc c urs in a ny of the c onstitue nts of a c re dit inde x, the
Prote c tion Se lle r pa ys the Prote c tion Buye r for the loss c a use d due to the a ffe c te d
e ntity. Afte r the Cre dit Eve nt, a ne w ve rsion of the inde x will be issue d with the
de fa ulte d e ntity re move d. The notiona l a mount use d for c a lc ula tions would be
re duc e d by a n a mount c orre sponding to the we ight of the e ntity in the inde x
(a ssuming 50 na me s in the inde x, the ne w ve rsion will c onta in 49 e ntitie s a nd will

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3/22/16 Credit Risk (CDS Indices) | Japan Exchange Group

ha ve a re vise d notiona l). Inte rna tiona l Swa ps a nd De riva tive s Assoc ia tion, Inc .
(ISDA) a dministe rs the de te rmina tion of Cre dit Eve nt a nd se ttle me nt me thods.

Disclaimer

The da ta ha s be e n provide d on a n "a s-is" a nd "a s-a va ila ble " ba sis. N e ithe r Osa ka
Exc ha nge , Inc . , Ma rkit Group Limite d, its a ffilia te s nor a ny da ta provide r sha ll in
a ny wa y be lia ble to you or a ny third pa rty for a ny ina c c ura c ie s, e rrors or
omissions, re ga rdle ss of c a use , in the da ta , c onte nt, informa tion a nd a ny
ma te ria ls on the site or for a ny da ma ge s (whe the r dire c t or indire c t) re sulting
the re from. Without limiting the fore going, Both Osa ka Exc ha nge , Inc . a nd Ma rkit
Group Limite d sha ll ha ve no lia bility wha tsoe ve r to you, whe the r in c ontra c t
(inc luding unde r a n inde mnity), in tort (inc luding ne glige nc e ), unde r a wa rra nty,
unde r sta tute or othe rwise , in re spe c t of a ny loss or da ma ge suffe re d by you a s a
re sult of or in c onne c tion with a ny opinions, re c omme nda tions, fore c a sts,
judgme nts, or a ny othe r c onc lusions, or a ny c ourse of a c tion de te rmine d, by you
or a ny third pa rty, whe the r or not ba se d on the da ta , c onte nt, informa tion or
ma te ria ls c onta ine d on the site .
The da ta displa ye d is for vie wing purpose s only a nd sha ll not be c opie d,
re distribute d, tra nsfe rre d, or use d in a ny ma nne r, inc luding without limita tion in
the provision of se rvic e s to third pa rtie s, without the a ppropria te lic e nse from
Ma rkit.

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