Basic CDS Index Analytics--Part 2: High Yield

Two weeks ago DWpublished a Learning Curve about investment grade credit derivatives indices, which looked at calculating and hedging the index. This article deals with the pertinent elements for their high-yield equivalents.

High-yield credit-default swap indices are quoted in price terms, unlike their investment-grade equivalents, which are quoted in basis points. A high-yield CDS index with a net-present value of zero will be quoted as having a price of 100. An index with a negative NPV will be quoted at a discount to 100, while one with a positive NPV will be quoted at a premium.

This difference in quotation convention is reflected in other terminology. For instance, buying a high-yield CDS index means going long risk, while "buying" an investment grade index or any single-name CDS contract means being long protection and short risk.

As an example of how to compute the price of a high-yield CDS index, consider the CDX.NA.HY maturing on Sept. 20, 2009. This index has a fixed coupon of 430 basis points. At a spread of 430bps its clean price is 100. Suppose the CDX.NA.HY spread moves to 500bps. The index NPV drops by 2.78% and the quoted price becomes 97.12. An investor who sold the index at par (went short risk) would realize a gain of 2.78%. As with the investment grade indices in Part 1, we can use Bloomberg's CDSW to perform this calculation.

The traded sub-indices of the CDX.NA.HY index, which we will denote "the 100s" because it contains 100 names, are the CDX.NA.HY.BB and the CDX.NA.HY.B. Currently, the two sub-indices have coupons of 290bps coupon and 480bps, respectively. We will call the collection of names in the 100s, but not in the BBs or the Bs, the implied CCCs index even though it contains several unrated names.

The methodology presented in the June 21 article to extract the LVOL component from the CDX.NA.IG can be applied to extract the CCC sub-index from the CDX.NA.HY.

The figure shows the market levels of CDX.NA.HY, BB, B and the implied level of the CCC sub-index.

The implied CCCs gapped from about 1,000bps in the beginning of May to above 1,600bps. More recently, the implied CCCs settled around the mid 1,400s.

 

This week's Learning Curve was written by Alex Reyfman, head of credit derivatives research, and Kristina Ushakova, analyst, at Bear Stearns in New York.