Credit Spread Risk




In the context of Bonds

This is called the Yield Spread


Term structure of credit spreads
Issuer curves
Benchmark spot rate curves


Spread over benchmarks, typically on the run TSY with the same maturity TSY -


Different Yields - Spot Curve
Different Yield Spreads - Credit Curve


Bonds - Credit Risk
Z-Spread - flat spread over chosen curve required to discount the bond cashflow back to the market price (you could use treasury curve or libor curve) Not used for quoting but is used in risk management (ie var models)


Asset Swap
Buy a coupon paying bonds and then swap the fixed coupon payments for a floating cash flow (using an interest rate swap) When you buy the bond you are taking on the credit risk of the bond the floating rate represents this credit risk) (this was used before the credit default swap was introduced)


OAS Spread
Takes into account interest rate volatility


BCDS Spread
Bond CDS (?)
Uses all the same inputs and conventions as the CDS spread and the output is also consistent Takes into account recovery rate of a bond, interest rate and credit spread volatility, directly comparable to CDS spread It is like an OAS spread taking into account the credit spread volatility



Credit - Credit Risk Models - create page There are two main types:
1) structural - based on fundamental analysis of the company, ratios etc Sharpe ratio, pre-tax interest coverage, leverage, cash flow, net assets, working capital


Rating agencies use this type of model


2) reduced form - takes inputs from the market Statistical analysis of default Jarrow/Turnbull used in CDS market





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