By Merrill Lynch
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Extra resources for Credit Derivatives Handbook - Volume 2
All levels are indicative as of 30thJanuary 2006; Assume exchange of deltas at mid; Equity tranche trades Upfront + 500bps Source: Merrill Lynch Tranche width is the difference between the detachment and attachment points. The notional amount of the underlying portfolio can be determined by dividing the tranche notional by the tranche width. For example, a $40mn notional of the 3-7% tranche implies an underlying CDX IG notional size of $1bn ($40mn/4%). 12 Both indices roll every six months around 20th September and 20th March.
See Volume 2, Chapter 5 for a detailed discussion of leverage Refer to important disclosures on page 196. Credit Derivatives Handbook 2006 – Vol. e. the buyer pays the full (discounted) protection premium at trade inception. Upfront traded tranches have a lower sensitivity to credit spread movement… Compared to tranches that trade on a running basis, upfront traded tranches are less sensitive to credit curve movements21. The upfront payment convention, however, is sensitive to changes in underlying interest rates.
Chart 38: All Underlying CDS Spreads = 150 bps Tranche Premium Tranche Premium Chart 37: All Underlying CDS Spreads = 100 bps 25% 35% 45% 55% 65% 75% 25% 35% Source: Merrill Lynch Mezzanine 55% 65% 75% Default Correlation Default Correlation Senior 45% Senior Equity Mezzanine Equity Source: Merrill Lynch Refer to important disclosures on page 196. 45 Credit Derivatives Handbook 2006 – Vol. 2 – 14 February 2006 Delta Hedging Dealers typically manage the spread risk of a tranche by using single-name CDS as an offsetting hedge.