Credit Default Swaps is a Credit Derivative which was created by JPMorgan Chase in 1997 to shift risk of default to a Third

Party. Credit default swaps CDS is a contract which allows one party to "buy" protection from another party for losses that might be incurred as a result of default by a specified reference entity. The "buyer" of protection pays a premium for the protection, and the "seller" of protection agrees to make a payment to compensate the buyer for losses incurred upon the occurrence of any one of several specified "credit events. Credit Default Index - A CDX product is similar to a CDS, however CDX compromises of a Group Reference entities instead of a Single Reference entity.

Example Lets assume that a Pension fund has a lot of money to invest, while a corporation wants to finance its debt through issuing bonds, the corporation issues a 10 year bond with 10% coupon rate, which seems a good fit for the pension fund manager. But as pension fund need to invest in very secure funds as the retirement funds are of people so the pension fund can only invest in very safe instruments. The Credit rating agencies, which are Standard & Poor, Moodys & Fitch have given the corporation a BB rating which does not allow the Pension fund manager to invest in the corporation as per the pension fund charter due to which the transaction is not allowed. So what the Pension fund manager does is that he approaches another entity which can be a Bank, an insurance company, some specialized companies who have a AA or above rating which are almost risk free they are as secured as the government. Now what does the Bank do is that they ask an insurance premium amount from the Pension fund out of the coupon interest that they are going to receive to provide insurance to the transaction due to which the bonds effectively become a AA rated bonds. There could also be another way that the corporation directly approach the bank and provide premium to the bank and insure the bonds before issuing the same to the pension fund so that and pay a 9% coupon to the pension fund coz of which the corporation bonds become a AA rated bonds as well as the pension fund is insured that in case the corporation defaults it has the Bank assurance for the amount invested to be repaid. Therefore, Underlying entity Corporation Bonds Fixed Rate The Insurance Premium rate / 1 % Notional Amount 10 Million $

Risk Involved Operational Risk - The Risk of Loss resulting from inadequate or failed processes or systems, Human factors (Fraud, Negligence) or External Events. Legal Risk - The Risk that the client may not have the legal capacity to enter into a transaction or the contracts cannot be enforced or that a party may not be compliant with laws & Regulations in the relevant jurisdiction. Market Risk - The Risk of Loss in value of financial instruments such as Derivatives, Bonds or Shares caused by the adverse movements in the market rates. Credit Risk - The Risk of Loss from the default of the counterparty or a worsening of the credit profile of the counterparty. Reputational Risk - The Risk of a decline in customer base, revenue reductions or costly litigation arising from negative publicity, whether founded or not. Trade Life Cycle Client On Boarding After an extensive on the clients and when we are satisfied that the Risk can be mitigated the clients are welcomed. Trade Execution It occurs when trades either buy or sell a financial product on the exchange or off it. Trade Capture The Trade details of the counterparty are collected and are properly inserted into the relevant risk management system. Profit/Loss Reporting Here we come to know what is the amount of Profit/Loss generated and if it is realized or unrealized. Confirmation The details provided by the Investor are been confirmed with the client. Settlement Here all the Pre settlement, settlement & Post Settlement activities are performed. Accounting General Ledger Reconciliation process is the reconciliation of month end general ledger balances to the sub ledger and source transaction system.

Trade Events New Trade CRE Fresh Trade. Full Novation FN Remaining Party. Partial Novation PN Remaining Party. New Full Novation NFN JPMC stepping in 100 %. New Partial Novation NPN JPMC stepping in partially. Unwind USW Termination. Unwind Step out Full USF JPMC stetting out of the trade. Unwind Step out Partial USP JPMC stepping out partially of the trade. Credit Events A Credit Event is where a Legal Entity fails to meet it Obligation or any Financial Transaction. Types of Credit Events Bankruptcy Legally declared inability to pay some or all of its creditors Failure to Pay Failure to make payment when & where due, can be either interest or principal on one or more debt obligation. Restructuring NO (NR) Does not constitute a Credit event OLD (OR) No restrictions on Modified (MR) Modified Modified (MMR) Obligation Acceleration Obligation Default Repudiation / Moratorium