Credit derivatives- S2000 magician sir help


Please explain fundas of Total return and Asset return swaps

a) Which risks they eleminate

b) Which risks are left in them

c) What happens when they combine with CDS ?

man, don’t abuse his generosity. I’m sure he knows the answer but I’m sure there also other people who can answer this or you can figure it out using your books.

This just sounds like a ridiculously lazy question! Just search on youtube for some videos on this.


Hang in there Vicky, we are all getting pummelled, but i will agree that it is generally more useful to ask very specific questions.

credit risk!

i wil try to explain as i have understood it. welcome to be corrected.

Total Return swap transfers all credit and market risk from total return payer to total return receiver.

Example :

A 's funding cost is LIBOR + 20 bps

B 's funding cost in LIBOR + 70 bps

both enter into total return swap. A buys a bond @ LIBOR +20 and passes total return to B @ LIBOR + 50 (called the negotiated spread)

A earns the difference between his funding cost and negotiated spread. B gets exposure to the bond at lower than his cost of funding.

Asset Swap: An entity who own a fixed rate bond enters into an interest rate swap as fixed rate payer.He pays the fixed coupon he receives from the bond into the swap and receives floating rate from the swap. Thus he has eliminated his interest rate risk. The credit risk however remains.

the coupon rate on the bond is mostly higher than the prevailing swap fixed rate and the floating rate payments on the interest rate swap are increased by the difference between the coupon rate on the bond and the swap fixed rate.this difference is the asset swap spread.a compensation for bearing credit risk.a CDS spread also reflects credit risk. so they are somewhat similar.

CDS spread can be higher or lower than asset swap spreads

CDS spread is lower than asset swap spread.

Go long on asset swap spread. i. e buy the fixed rate bond .pay fixed coupon received into an interest rate swap as a fixed rate payer and receive asset swap spread on floating rate. thus interest rate risk eliminated and higher asset swap spread compared to CDS spread received on floating rate payments.

credit risk remains. buy protection through CDS paying lower CDS spread.

Effect : Receive higher asset swap spread pay lower CDS spread. the difference is riskless arbitrage profit.

CDS spread greater than asset swap spread

you can in theory do opposite of the above but there are difficulties in shorting bonds in illiquid markets.

You mean we will go long on higher of asset or CDS spread? Normally we go long on less priced one

I think there’s a free Elan video on youtube you can watch if you want. Someone posted the link a while back

higher spread => lower price.

for ex. 2 bonds with same maturity say 8 years. coupon,par value are same for both.assume both are govt paper.

bond 1 trades @ spread of 15 bps over 7 year paper

bond 2 trades @ spread of 20 bps over 7 year paper.

which one would you buy?

Yes will have to watch the video man