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Preface xiii
About the Authors xv
Chapter 1
Introduction 1
Part One: The Cash Market 2
Part Two: The Structured Markets 3
Part Three: The Synthetic Markets 4
Part Four: How to Trade the Leveraged Finance Market 5
Part Five: Default Correlation 6
Part One
The Cash Market 9
Chapter 2
The High-Yield Bond Market 11
The Reasons Companies Are Classified as High-Yield Issuers 11
Size and Growth of the Cash Market 13
Types of Structures 21
A Look at Ratings 22
Risk and Return for Bonds 26
What’s Priced In? 31
How About Recoveries? 35
Summary 37
Chapter 3
Leveraged Loans 39
A Tale of Two Loans 39
Introduction to Leveraged Loans 42
An Overview of Loan Terms 56
Loan Recovery Rates 65
Loan Default Rates 73
Summary 79
Part Two
Structured Market 81
Chapter 4
Collateralized Loan Obligations 83
Understanding CLOs 83
Elaborations and Details 92
Summary 104
Chapter 5
CLO Returns 105
Default and Recovery Scenarios 105
Distressed Loan Prices, Overflowing Triple-C Buckets, and CLO Returns 119
Summary 129
Chapter 6
CLO Portfolio Overlap 133
Collateral Overlap in U.S. CLOs 134
Collateral Vintage vs. Deal Vintage 142
Favorite CLO Credits 142
Single-Name Risk and Tranche Protections 146
Excess Overcollateralization and Excess Overcollateralization Delta 150
Senior and Subordinate Excess OC Deltas 151
Equity Tranches and Distressed Tranches 157
Summary 157
Part Three
Synthetic Markets 159
Chapter 7
Credit Default Swaps and the Indexes 161
What Are Credit Default Swaps? 162
Who Uses Protection, and for What? 168
Growth of the Market 168
Marking-to-Market: SDV 01 170
Credit Default Swaps Indexes 172
Contrasting the LCDX and CDX Indexes 177
Beta: A Study of Movement 178
Summary 183
Chapter 8
Index Tranches 185
Basic Mechanics of the Tranche Market 185
Loan Tranches 195
Summary 199
Part Four
How to Trade the Leveraged Finance Market 201
Chapter 9
Recessions and Returns 203
Broad Market Performance 204
Sector Performance 207
Performance by Rating 207
Summary 210
Chapter 10
Framework for the Credit Analysis of Corporate Debt 211
Approaches to Credit Analysis 211
Industry Considerations 216
Financial Analysis 220
Quantitative Models 232
Summary 233
Chapter 11
Trading the Basis 235
The Basic Basis Package 236
Constructing the Basic Package 236
Moving Away from the Basic Model 240
Adding Positive Convexity 249
Negative Convexity 254
A More Complex Basis Package 255
Hedge Ratios for CLO Hedging 259
Summary 260
Chapter 12
How Much Should You Get Paid to Take Risk? 263
Single-Name Credit Risk 263
Curve Risk 267
Basis Risk 269
Capital Structure Risk 274
Summary 281
Part Five
Default Correlation 283
Chapter 13
Default Correlation: The Basics 285
Default Correlation Defined 285
Default Probability and Default Correlation 291
Summary 309
Chapter 14
Empirical Default Correlations: Problems and Solutions 311
Empirical Results 311
Problems with Historical Default Correlations 315
Proposed Solutions 318
Summary 333
Index 335
