W
welsh_owen
Member
Again I return......,
Recapping on the section 6 of chapter 15 the notes cover how to measure credit risk. one particular approach considers using asset swaps for this purpose.
Based on what I have read in the notes and in the Hull text book I am led to believe that under a swap of this nature the known coupons from a reference corporate bond (or index) are paid away (irrespective of whether the coupons are actually paid by the issuer) and in return a floating rate of LIBOR + a margin is received.
I believe that at outset an adjustment is made so that both sides of the swap are effectively based on a par value of 100. I.e. if the underlying corporate bond is trading at below 100 then the party paying the floating rate will increase their spread (such that the pv of these additional payments equals 100 - MV of bond). Conversely the margin is decreased if the bond is trading above par.
My question relates to whether this is actually an accurate way to measure credit risk? Subject to my understanding being correct an asset swap takes no allowance for the principle amount defaulting. Should the happen the party paying the coupons would be severely disadvantaged.
Assuming the steps set out above are correct it this measure therefore sufficiently accurate to measure the credit risk associated with a specific corporate bond issue?
Recapping on the section 6 of chapter 15 the notes cover how to measure credit risk. one particular approach considers using asset swaps for this purpose.
Based on what I have read in the notes and in the Hull text book I am led to believe that under a swap of this nature the known coupons from a reference corporate bond (or index) are paid away (irrespective of whether the coupons are actually paid by the issuer) and in return a floating rate of LIBOR + a margin is received.
I believe that at outset an adjustment is made so that both sides of the swap are effectively based on a par value of 100. I.e. if the underlying corporate bond is trading at below 100 then the party paying the floating rate will increase their spread (such that the pv of these additional payments equals 100 - MV of bond). Conversely the margin is decreased if the bond is trading above par.
My question relates to whether this is actually an accurate way to measure credit risk? Subject to my understanding being correct an asset swap takes no allowance for the principle amount defaulting. Should the happen the party paying the coupons would be severely disadvantaged.
Assuming the steps set out above are correct it this measure therefore sufficiently accurate to measure the credit risk associated with a specific corporate bond issue?