Credit Derivaties

Credit Derivatives and Quantitative Research
New York, London January 2005

Credit Derivatives: A Primer

About this primer
This primer introduces credit derivatives to new users and explains how to value and trade them. The supporting graphs, exhibits, footnotes, and appendices further aid the reader in learning about credit derivatives. JPMorgan publishes daily reports that analyze the credit derivative markets. To receive electronic copies of these reports, please contact a Credit Derivatives research professional or your salesperson. These reports are also available on www.morganmarkets.com.

Contents
1. 2. 3. 4. 5. 6. 7. Introduction 1 The credit default swap 2 Valuation 5 Importance 10 Market participants 12 Credit default swap index products 14 Other credit derivative products 19 Credit default swap options Digital default swaps and recovery swaps Constant maturity credit default swaps and credit spread swaps First-to-default baskets Collateralized debt obligations and tranched indices 8. Logistics of trading 23 Accounting and marking to market Standardized documentation Counterparty considerations 9. Appendices 27 Credit Derivatives: A Primer is available on: http://www.morganmarkets.com

1. Introduction
A credit derivative is a financial contract that allows one to take or reduce default exposure, generally on bonds or loans, of a sovereign or corporate entity. The contract is between two parties and does not directly involve the issuer itself. Credit derivatives are primarily used to: 1) reduce risk arising from ownership of bonds or loans 2) take exposure to an entity, as one would do by buying a bond or loan, and 3) express a positive or negative credit view on a single entity or a group of entities, independent of any other exposures to the entity one might have. Since its introduction in the mid-1990s, the growth of the credit derivative market has been dramatic: • The notional amount of credit derivative contracts outstanding at the end... [continues]

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