Case study - itraxx, Financial Management

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(a) iTraxx is a group of credit derivative index managed by the International Index Company (IIC) and covering Europe and Asia and Australia. The body in the portfolio forming the indices are selected on the basis of trading volume and liquidity of the underlying CDS. For instance the iTraxx Europe index comprises of 125 investment grade names.

(b) The standard tranche for a credit index is a tranche with pre-specified lower as well as upper attachment point making it much more liquid than tranches created individually by negotiating with market makers. The subsequent are the standard attachment points representative the percentage of defaults protected by the seller of the tranche:

Equity tranche: first 0 - 3%

Mezzanine tranche: 3 - 6%

Senior tranche: 6 - 9%

Super senior tranche: 9 - 12%

(c) We can mention the subsequent few differences

Standardized tranches of credit indices are unfunded and hence no cash payment is involved whereas tranches of CDO's issued in the market by banks or else hedge funds may be funded and requires cash payment.

For the standardized tranches the fraction of default that it protects is previously determined on the other hand tranches of CDO's issued in the marketplace depends on the issuer (bank or hedge fund).

The underlying portfolios are probable to be different.

The standard tranches are additional liquid than tranches issued by banks and hedge funds.


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