Table Of ContentA P
DVANCE RAISE FOR
C D
REDIT ERIVATIVES
‘a really comprehensive [and] thorough treatise. … an essential
road map for students, investors, traders, and regulators of credit
derivatives anywhere in the world, especially in new markets,
where these securities are being introduced. … accessible for readers
coming at the subject at different levels of quantitative training, and
for practitioners of varied viewpoints. There is something here for
everyone interested in the credit markets.’
—Professor Sanjiv Das, William and Janice Terry Professor of
Finance, Santa Clara University
‘a very well-written introduction to credit derivatives, with an
emphasis on credit default swaps. … covers a wide swath of material
on the topic and includes recent developments and regulations in
India, in addition to its usage in more mature, developed markets. The
reader can see how useful these instruments are; while, at the same
time, understand their ability to magnify bad outcomes. … It covers
all the essentials in a very easy to follow, structured, conversational
style. I strongly recommend the book.’
—Professor Suresh Nair, Professor and Ackerman Scholar,
University of Connecticut
‘a timely and much-needed volume about a key and less-than-widely-
understood class of instruments of financial risk sharing that can only
gain in importance in the years to come. A must-read for all serious
students and practitioners of finance as well as policymakers.’
—Professor Rajesh Chakrabarti, Executive Director,
Bharti Institute of Public Policy, Indian School of Business
‘This book is a significant contribution to finance literature. It explains
Credit Derivatives market in detail and in simple terms including its
specifications, valuation, accounting and legal issues. I am sure, a
wide cross-section of market participants would be able to come up
to speed and would benefit immensely from this book.’
—G. Gopalakrishna, Director, Centre for Advanced Financial
Research and Learning (CAFRAL), Reserve Bank of India
‘The timing of the book is very apt as it comes closely on the heels
of policymakers and market participants grappling with what is the
right way to get Credit Derivatives going in the onshore market. …
This book does justice by bringing into attention the goodness of the
product as well as the red herring of the product. … a very well timed
book, quite comprehensive in its scope and a must-read for someone
who intends to understand the subject. … Vaidya blends concepts
and practice very well and makes full justice of his background.’
—Anup Bagchi, Chief Executive Officer and Managing Director,
ICICI Securities Limited
‘This book takes up a complex topic and succeeds largely in
simplifying it for the reader. It is essential reading for those wanting
an introduction to credit derivatives.’
—Anantha Nageswaran, Former Chief Investment Officer
and Head of Research, Julius Baer, Singapore
‘The book systematically explains product mechanics and lucidly
places them in the context of regulatory frameworks. It would be
of value to market practitioners, policymakers, academics and
regulators alike.’
—Dr Ranjan Chakravarty, Former Chief Risk Officer, Singapore
Mercantile Exchange and Clearing Corporation
‘the book has tremendous learning value. Vaidya provides an easily
comprehensible, building-block approach to credit derivatives,
starting from the basics to discussion on esoteric instruments. Recent
developments such as Big Bang have also been discussed at length. To
complete the picture, Vaidya provides guide to ISDA documentation,
regulatory issues as well as accounting treatment. Vaidya not only
explains the subject, but concludes the book by providing his take on
the policy implications on the subject. Vaidya’s book would be a great
read and a reference for anyone interested in this fascinating subject.’
—Vinod Kothari, internationally renowned Author
and Expert on credit derivatives
‘The appealing part of the book … is the lucid style of presentation
of a complex subject like credit derivatives. The coverage is full, even
though the complex mathematical pricing issues have been avoided.
This book will be useful to students as well as practitioners. With
India opening the market for credit derivatives, this book is a very
timely addition in enhancing the knowledge on this subject.’
—Professor B.B. Chakraborty, Director,
Indian Institute of Management, Ranchi
‘Bankers have been searching for a book like this. … a comprehensive
book on credit derivatives. It discusses the credit default swap
instrument as it is used in India and risk management along with the
pertinent RBI guidelines. This book addresses a long-felt need for a
complete handbook for credit derivatives.’
—N.S. Venkatesh, Executive Director, IDBI Bank
Former Managing Director and Chief Executive Officer of IDBI Gilts
‘This is a compulsory read for entry level professionals whose work
concerns credit derivatives. The book covers in sufficient depth and
detail, financial, accounting and legal aspects related to credit default
swaps in India. The policies and guidelines in the appendix are
impressive and informative.’
—K. Selvaraj, Former Chairman FIMMDA and Head of Forex,
Financial Engineering & New Products, State Bank of India
‘This book is a well written text on the subject and covers most of the
aspects required to be known by the Traders as well as Risk Managers,
and is a good piece of reference.’
—Ashutosh Khajuria, President – Treasury, Federal Bank
‘The book has excellent coverage of Credit Derivatives and is quite
pertinent in the Indian Financial Markets context. I would recommend
it as a mandatory reading for all capital market professionals and as
a reference book for senior bankers in India.’
—Ashish Agarwal, Chief Risk Officer, Yes Bank
‘one of the masterpiece works. The release of the book is both topical
and timely … a refresher book for treasury managers, risk managers,
traders and investment bankers and a “must-read” book for students
and teachers of finance.’
—V. Sriram, General Manager, SIDBI
K. Vaidyanathan
Faculty in Residence
University of Connecticut
McGraw Hill Education (India) Private Limited
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Credit Derivatives
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F
OREWORD
Credit risk represents the key risk that commercial banks assume. In recent
years, new instruments for managing credit risk have evolved in emerg-
ing financial markets. Credit Default Swap (CDS) is one such instrument
that has been introduced in the last couple of years in India and China by
their respective Central Banks.
CDS allows banks to separate credit origination from credit risk. From
an economic point of view, this separation generates benefits as banks
can extend their lending without being constrained by their risk-taking
capacity. By buying or selling credit protection, banks make the credit risk
tradable and shift the credit risk out of their balance sheets to other market
participants who are better able to bear this risk or who wish to diversify
their portfolios.
In India, the Reserve Bank of India (RBI) introduced CDS for banks
and security houses in November 2011. Subsequently, the Securities
and Exchange Board of India (SEBI) allowed Mutual Funds to use
CDS in November 2012. In December 2012, Insurance Regulatory and
Development Authority (IRDA) permitted the use of CDS for insurance
companies in India. Since credit derivatives are relatively new to Indian
financial markets, a clear understanding of this instrument is a must for
practitioners, regulators, academics and students. Vaidya’s book fulfils this
important need as it covers the essential body of knowledge to provide a
good understanding of this newly introduced asset class.
Vaidya has been a practicing professional who honed his craft at
one of the leaders in credit derivatives market. The book reflects this
practitioner orientation: it covers the essential nuts and bolts of this asset
class in a lot more detail when compared to standard textbooks. Features
of CDS contracts are explained in detail; these include their standard
fee structure, payment dates, standardization of accruals, frequency,
scheduled termination dates, day count conventions, maturity, reference
entities, reference obligations, etc. The book covers the valuation of both
x Foreword
liquid and illiquid CDS taking the CDS conventions into account, as is
the market practice. Investor strategies and indices are discussed, as also
the new conventions in the global credit derivatives market such as the
big-bang and the small-bang protocols. The book describes in reasonable
detail the settlement of CDS contracts in case there is a credit event; both
eventualities of physical and cash settlement are covered. In the case of
physical settlement, the conditions for payment, such as the credit event
notice period and Notice of Physical Settlement (NoPS) are covered in
necessary detail. In case of cash settlement, the process that would be
followed by the Indian Credit Derivatives Determinations Committee
set up by the RBI nominated entity—FIMMDA (Fixed Income Money
Market and Derivatives Association of India) is included in appropriate
detail. Regulatory treatment of Credit Derivatives under the Basel III
framework as well as the simpler framework used by the RBI is reviewed.
The accounting treatment for CDS, more specifically, hedge accounting for
CDS under the FAS, IFRS and Indian Accounting standards are covered.
The last three chapters deliberate on the evolution of the market for credit
derivatives, their real effects on the economy, and their policy implications.
Vaidya’s book provides a complete treatment of this important and in-
novative asset class. I foresee it being a standard reference for all stake-
holders of this financial product in India.
VIRAL V. ACHARYA
C.V. Starr Professor of Economics, Department of Finance,
NYU Stern School of Business, New York
Director, NSE-NYU Stern Initiative on the Study of Indian Capital Markets
Research Associate in Corporate Finance, National Bureau of
Economic Research (NBER)
Research Affiliate, Centre for Economic Policy Research (CEPR)
