Key Concepts
- CDS Basis
- The difference between the Z-spread on a bond and the CDS spread of the same maturity for the same issuer.
Credit Strategies
- Excess Spread
- \[ E \approx \text{Spread}_0 - (\text{EffSpreadDur}\times \Delta \text{Spread}) - (\text{POD}\times \text{LGD}) \]
Synthetic Credit Strategies
CDS allow an investor to manage credit risk separately from interest rate risk. CDS pay out the loss given default in a credit event.
\[ \text{CDS Price} \approx 1+((\text{Fixed Coupon} - \text{CDS Spread}) \times \text{EffSpreadDur}_{\text{CDS}}) \]
\[ \frac{\Delta\text{CDS Price}}{\Delta \text{CDS Spread}} \approx -\Delta\text{CDS Spread}\times \text{EffSpreadDur}_{\text{CDS}} \]
Five year CDS are the most frequently traded tenor.
The fixed coupon is usually 1% for an investment grade or 5% for a high yield CDS.
The protection buyer is short and the seller is long.