Learning Curve

The complex security design of collateralized debt obligations is arranged and administered like a managed fund, allowing issuers to refinance the purchase of debt instruments by repackaging them into different slices of risk and maturity.

As popular as synthetic collateralized debt obligations have become, modeling and pricing these securities continues to provide a number of unique challenges.

The Black Scholes option pricing model assumes stock prices are lognormally distributed.

In 2004, the International Swaps and Derivatives Association formed a committee to draft a form of credit-default swap for asset-backed securities with a view toward jump starting the synthetic ABS market.

In the past few months, equity volatility trading has seen an unprecedented level of interest from investors who have traditionally traded equities, bonds, currencies and other common asset classes.

Credit derivatives such as CDOs have become extremely popular as they represent a straightforward vehicle for credit correlation trading.

The 2005 Novation Protocol was published Sept. 12 by the International Swaps and Derivatives Association partly as a result of the pressure which regulators have put upon their regulated institutions to cut backlogs of trade confirmations, and partly as a result of the evolution of market practices whereby novations are not effected legally, despite the intention of the parties involved.

Like credit-default swaps, equity-default swaps are bilateral contracts.

A recent case in London's Commercial Court, Peekay Intermark v Australia and New Zealand Banking Group, highlights what can go wrong if a salesman misrepresents the nature of a product to an investor, even a sophisticated investor.

"Some of the U.K.'s largest investment institutions are planning to launch a property derivatives market in an attempt to put commercial property on an equal footing with other financial assets."

According to a 2002 report released by the U.S. Department of Commerce's National Institute of Standards and Technology (NIST), software errors (or bugs) cost the U.S. economy USD59.5 billion annually.

The dividend swap market has been very active and has made strong gains this year.