A Review of Appropriable Credit Derivatives

Abstract

The approach pursued in this thesis requires pairs of CDSs referencing differently-ranked debt of a single issuer, as the previous chapter showed. To the end of identifying suitable combinations, Section 4.1 provides an overview of debt instruments typically employed by non-sovereign issuers to fulfill their financing needs, and briefly describes the different types of CDSs outstanding thereon. The discussion reveals that workable combinations will consist either of two CDSs referencing differently-ranked bonds or of a CDS referencing a high-yield bond and an LCDS referencing a leveraged loan. In the former case, a combination is straightforward as CDS transactions are commonly concluded based on broadly accepted standard terms which are identical irrespective of the underlyings’ seniority. In the latter case, however, complications arise from several fundamental particularities of LCDSs, and a diligent assessment of this matter is required. For that purpose, Section 4.2 reviews the key characteristics of leveraged loans and bonds, thus preparing the ground for Section 4.3, in which the properties of CDSs and LCDSs are compared in greater detail. Section 4.4 then attempts to quantify the effect of divergent provisions and evaluates the usability of U.S. and European LCDSs, respectively, for the purpose of this thesis.