Default recovery rate swaptions: A financial engineering instrument to transfer post-default recovery rate risk

• Main Author: Zalameda, Milkos Patrick B.
• Format: text
• Language: English
• Published: Animo Repository 2008
• Subjects: Derivative securities; Finance and Financial Management
• Online Access: https://animorepository.dlsu.edu.ph/etd_masteral/3783; https://animorepository.dlsu.edu.ph/context/etd_masteral/article/10621/viewcontent/CDTG004591_F_Partial.pdf
• Institution: De La Salle University

There are many types of credit derivatives. Credit derivatives are divided into two categories of product, funded credit derivatives and unfunded credit derivatives. An unfunded credit derivative is a bilateral contract between two counterparties, where each party is responsible for making its payments under the contract (i.e. payments of premiums and any cash or physical settlement amount) itself without recourse to other assets. In a funded credit derivative, the credit derivative will be embedded into a bond and bondholders will be responsible for the payment of any cash or physical settlement amounts. The statement of research objectives of the study: 1. To be able to design and study the valuation of a new financial product that allows market participants to trade recovery rate risk of defaulted securities. 2. To be able to determine appropriate calculation methodologies for recovery rates. 3. To be able to derive a pricing structure for the said financial product. 4. To be able address the other important aspects of a financial product such as risk management, accounting, and documentation. The study will allow financial institutions to hedge their recovery risk on nonperforming assets through this new financial instrument. It can also allow them to reduce the required regulatory capital, particularly on banking institutions. The study will prove to be useful as future reference for related thesis and other papers of researchers and the academe. The paper will also serve as a catalyst to stimulate additional studies focusing on the application of financial engineering in making the global financial market more dynamic.