Home > General Topics > Trading > Case Study Question

Case Study Question

  1. Hello everyone, this is my first post. I’m a beginner novice learning about credit default swaps and relative value trades and I came across a case study with this explanation. I have spent hours trying to decipher this, but I am struggling. Please help.

    “...putting a relative value trade will cost £15.5k over 6 months. £13k of the £15.5k can be attributed to roll down. In order to break even on this trade, the absolute price ratio needs to converge from the current level of 1.4 down to 1.32. Considering the current state of Y’s credit and looking at historical data, it is believed that the price ratio will reach 1.2 (ratio at just after issuance) resulting in 18k profit.”
    Some Info: X-spread = 567, Y-spread = 403. Therefore spread ratio, 5.7:4 = 1.4:1

    How has £18k been calculated? I’m sure it’s very simple, but I’d appreciate if someone could point it out to me.

    Thank you very much. I hope I've posted in the correct place; apologies if this is not so.
     
  2. Actully the profit will be 17K.
     
  3. When I see stuff like that, right away I know there is a problem.
     
  4. You haven't provided enough information on the trade.
     
  5. feel free to PM me
     
  6. Thanks everyone

    Intradaybil, please tell me how you arrived at 17K.

    Hook N. Sinker, please elaborate on the problem you mention as I’d be more than happy to explain any misinterpretations.

    Martinhoul, what more information are you looking for? I’d be more than happy to look through the rest of the case study and provide.

    SarahNGuyen, thank you; I will take you up on that offer!
     
  7. Well thank you very much everyone! You have all been incredibly helpful and I leave satisfied with my dilemma solved.

    If it isn't obvious, I am being sarcastic.

    I came on here hoping the good community of Elite Trader might help me out, and apart from SarahNGuyen (who has forwarded me to the Maths guy, who still hasn't got back to me), you've all posted uselessly disparaging pretentious comments. What an absolute farce you lot are. :mad:
     
  8. This forum is for traders, it is not a finance tutoring service. People here do not have time to solve your homework problem for your midterm exam.
     

  9. People that want to be understood, communicate clearly.

    Sometimes people that wish to hide, hide by communicating in vague, complex, difficult to understand terms, such as:

    “...putting a relative value trade will cost £15.5k over 6 months. £13k of the £15.5k can be attributed to roll down. In order to break even on this trade, the absolute price ratio needs to converge from the current level of 1.4 down to 1.32. Considering the current state of Y’s credit and looking at historical data, it is believed that the price ratio will reach 1.2 (ratio at just after issuance) resulting in 18k profit.”


    When I notice someone communicating in a complex, difficult to understand way, I interpret their thinking as sloppy and not clear, likely to be faulty, and likely they are hiding something.

    I avoid unclear thinkers, and associate with clear communicators.

    My objective as a speculator is to make money, not to get tangled up in nonsense.
     
  10. If you still want the answer, you're gonna have to give me more info, I'm afraid... Doing it the simplistic way (with a few arbitrary assumptions) I am getting a PNL of arnd £20k plus. I can tell you what I am doing, as it's not exactly rocket engineering.
     
  11. Well jimbojim, you pretentious nonce, I specifically mentioned that I obtained this from a case study, and that I am learning about CDS trades, and would appreciate forum help. It is not for my 'midterm exam'...I have graduated and whilst I do not want to blow my own trumpet, I am an Oxford Physics graduate dealing with Mathematics far more challenging than this, so please do not patronise. HookNSinker, as I've mentioned, I've directly quoted this from a case study in a finance book, and so cannot be blamed for lack of clarity.

    Nonetheless, it turns I got the answer before any of you anyway.

    Here is my solution...

    I believe the reason I intially struggled was because the book was wrong. The answer is in fact 17K.

    Given 13k is the cost of the roll down, we assume for the max cost - 13k incurred. We are then told the break-even is when the ratio is down by 8 points, so 13/8 = 1.625 per point. After all, the fix part is fixed and not affected by the ratio changes.

    So for a 20 point improvement, you get 1.625*20 = 32.5k. Take 15.5k off and you get 17k.

    The possible 1 k difference is due to the spread cost, which is the fixed part (2.5k, so 1k is above mid spread), I suspect.


    Goodbye and goodnight.