What is the ISDA Master Agreement?

What is the ISDA Master Agreement?

The International Swaps and Derivatives Association (ISDA) is a professional association that was incorporated in 1985 for the trading of swaps and derivatives. ISDA was created as many financial institutions faced challenges on account of the increased use of derivatives & also due to the lack of risk clarity the parties to the transaction would face. ISDA Master Agreement is a standard contract to govern all over-the-counter (OTC) derivative transactions entered between the parties. OTC derivatives are mainly used for hedging purposes. For example, there is an adverse movement in the market and a company expects floating interest rates to increase, therefore, it can enter an interest rate swap to lock in the fixed interest rate for a specific period. (more…)
How are Futures Physically Settled in India?  

How are Futures Physically Settled in India?  

How are Futures Physically Settled in India? Derivatives contracts are either cash-based or physically distributed on the expiry date of the deal. When the contract is concluded in cash, the net cash value of the contract on the expiry date shall be passed between the purchaser and the seller. In a physical settlement, the payer trades the underlying asset for the notional principal at the end of the swap period/ futures contract. (more…)
What is CVA & XCVA?

What is CVA & XCVA?

What is CVA? Credit Valuation Adjustment (CVA) is the price that an investor would pay to hedge the counterparty credit risk of a derivative instrument. It reduces the mark to the market value of an asset by the value of the CVA. CVA is the most widely known of the valuation adjustments, collectively known as XVA. History Credit Valuation Adjustment was introduced as a new requirement for fair value accounting during the 2007/08 Global Financial Crisis. CVA has attracted much attention among derivative market participants and most of them have incorporated CVA in deal pricing. (more…)
How does SPAN Margin System work?

How does SPAN Margin System work?

How does SPAN Margin System work? Option/Futures margin, very simply, is the money that a trader must deposit into his or her trading account in order to trade. This is in contrast to a margin on Equity, which is rather a loan to you from your broker so that you can buy more stock with lesser capital. Next what we need to understand is that margin rules differ across various exchanges – which is to say that Chicago Board Options Exchange (CBOE) has a system completely different from what Chicago Mercantile Exchange (CME) uses to set its option margins. The later, along with the National Stock Exchange of India (NSE) and many other exchanges around the world use a system called SPAN. (more…)
What Are STRIPS?

What Are STRIPS?

Introduction to STRIPS:
  • STRIPS (Separate Trading of Registered Interest and Principal of Securities) are debt securities that are created through the method of coupon stripping.
  • They are similar to the traditional Treasury bonds, the only difference being that the bond's principal has been separated i.e. stripped off from its interest(coupon) making it two separate entities.
  • STRIPS are the form of zero-coupon securities, meaning that they make no periodic interest payments, as most bands do. Instead, we can buy them at a deep discount from their face value, which is the amount you receive when they mature.
  • Thus, investors know exactly how much they will earn from their STRIPS investments. This, plus the high security of the bonds that back them, make STRIPS popular with some investors.
  • Many brokerage firms created their own zero-coupon securities before 1986 by stripping the coupons from Treasury bills and bonds they purchased and held in escrow. Eg CATS, TIGRs, etc. Then the Treasury introduced the STRIPS system, in which brokerages create zero coupons based on book-entry receipts for Treasury instruments. STRIPS are sold by brokerage firms while they are based on underlying Treasury instruments.
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Functioning of Credit Default Swaps

Functioning of Credit Default Swaps

Functioning of Credit Default Swaps:
  • A credit default swap (CDS) is a credit derivatives instrument that provides insurance to the buyer [Protection Buyer] against the risk of a default by a particular company [Reference Entity].
  • The fundamental role of credit default swaps is to transfer credit risk between a party wishing to reduce credit risk, often called the protection buyer, risk seller or risk hedger (the party going short the credit), and the party wishing to acquire or hold credit risk, often called the protection seller or risk buyer (the party going long the credit).
  • Each CDS has a notional amount and it requires the buyer to pay a premium called CDS spread.
  • The credit event is binary in nature, i.e. it occurs, or it doesn’t.
  • Typical credit events include (a) a filing for bankruptcy by the third party on whose bond the CDS was issued, (b) any failure by the third party to pay interest on its bonds, and (c) any restructuring of the Debt.

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