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Credit default swaps in their current form have existed since the early 1990s and increased in use in the early 2000s. By the end of 2007, the outstanding CDS amount was $62.2 trillion, [3] falling to $26.3 trillion by mid-year 2010 [4] and reportedly $25.5 [5] trillion in early 2012.
The Z-spread of a bond is the number of basis points (bp, or 0.01%) that one needs to add to the Treasury yield curve (or technically to Treasury forward rates) so that the Net present value of the bond cash flows (using the adjusted yield curve) equals the market price of the bond (including accrued interest).
A credit default swap index is a credit derivative used to hedge credit risk or to take a position on a basket of credit entities. Unlike a credit default swap, which is an over the counter credit derivative, a credit default swap index is a completely standardized credit security and may therefore be more liquid and trade at a smaller bid–offer spread.
An alternative way to regard the higher yields of credit instruments is to regard them as being priced off different yield curves, where these credit curves lie above the reference curve. The lower the credit rating, the higher the spread, thus reflecting the extra yield premium demanded for greater risk.
A Credit valuation adjustment (CVA), [a] in financial mathematics, is an "adjustment" to a derivative's price, as charged by a bank to a counterparty to compensate it for taking on the credit risk of that counterparty during the life of the transaction. "CVA" can refer more generally to several related concepts, as delineated aside.
Default probabilities may also be estimated from the observable prices of credit default swaps, bonds, and options on common stock. The simplest approach, taken by many banks, is to use external ratings agencies such as Standard and Poors , Fitch or Moody's Investors Service for estimating PDs from historical default experience.
Asset swap § Computing the asset swap spread; Credit default swap § Pricing and valuation; Currency swap § Valuation and pricing; Interest rate swap § Valuation and pricing. Multi-curve framework; Variance swap § Pricing and valuation; Interest rate derivatives (bond options, swaptions, caps and floors, and others) Black model. caps and ...
Given: 0.5-year spot rate, Z1 = 4%, and 1-year spot rate, Z2 = 4.3% (we can get these rates from T-Bills which are zero-coupon); and the par rate on a 1.5-year semi-annual coupon bond, R3 = 4.5%. We then use these rates to calculate the 1.5 year spot rate. We solve the 1.5 year spot rate, Z3, by the formula below: