Synthetic and Structured Assets-A Practical Guide to Investment and Risk
Erik Banks
Copyright C
2006 John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester,
West Sussex PO19 8SQ, England
ISBN 13 978-0-470-01713-5 (HB)
ISBN 10 0-470-01713-9 (HB)
Acknowledgements ix
About the author xi
1 Introduction to Synthetic and Structured Assets 1
1.1 Development of structured and synthetic assets 2
1.2 Drivers of market activity 3
1.3 New product design 5
1.4 Overview of the text 7
2 Financial Building Blocks 9
2.1 Introduction 9
2.2 Concepts 9
2.2.1 Risks 9
2.2.2 Time value of money and interest rates 11
2.3 Derivative instruments 16
2.3.1 Derivatives 16
2.4 Host securities/liabilities 38
2.4.1 Public notes/shelf registrations 38
2.4.2 Private placements 38
2.4.3 Transferable loans 39
2.5 Issuing/repackaging vehicles 39
2.5.1 Special purpose entities 40
2.5.2 Trusts 41
2.5.3 Investment companies and partnerships 42
2.6 Financial engineering and product design 43
3 Callable, Puttable, and Stripped Securities 45
3.1 Introduction 45
3.2 Development and market drivers 45
3.3 Product mechanics and applications 47
3.3.1 Callable bonds 47
3.3.2 Puttable bonds 52
3.3.3 Stripped securities 53
4 Mortgage- and Asset-backed Securities 59
4.1 Introduction 59
4.2 Development and market drivers 59
4.3 Product mechanics and applications 62
4.3.1 Mortgage-backed securities 62
4.3.2 Asset-backed securities 90
5 Structured Notes and Loans 99
5.1 Introduction 99
5.2 Development and market drivers 99
5.3 Product mechanics and applications 102
5.3.1 General structural issues 102
5.3.2 Interest-rate-linked notes 104
5.3.3 Currency-linked notes 107
5.3.4 Commodity-linked notes and loans 109
5.3.5 Equity-linked notes 110
5.3.6 Credit-linked notes 113
6 Collateralized Debt Obligations 121
6.1 Introduction 121
6.2 Development and market drivers 121
6.3 Product mechanics and applications 123
6.3.1 General structural issues 124
6.3.2 Cash flow CDOs and market value CDOs 133
6.3.3 Balance sheet and arbitrage CDOs 134
6.3.4 Structured and synthetic CDOs 135
7 Insurance-linked Securities and Contingent Capital 141
7.1 Introduction 141
7.2 Development and market drivers 141
7.3 Product mechanics and applications 143
7.3.1 Insurance-linked securities 144
7.3.2 Contingent capital structures 153
8 Convertible Bonds and Equity Hybrids 163
8.1 Introduction 163
8.2 Development and market drivers 163
8.3 Product mechanics and applications 165
8.3.1 Convertible bonds and variations 166
8.3.2 Bonds with warrants 172
8.3.3 Buy/write (covered call) securities 173
8.3.4 Other equity hybrids 177
9 Investment Funds 181
9.1 Introduction 181
9.2 Development and market drivers 181
9.3 Product mechanics and applications 184
9.3.1 Structure, diversification, and management 184
9.3.2 Open-end funds 186
9.3.3 Closed-end funds 193
9.3.4 Hedge funds 195
9.3.5 Exchange-traded funds 200
10 Derivative Replication, Repackaging, and Structuring 205
10.1 Introduction 205
10.2 Development and market drivers 205
10.3 Product mechanics and applications 207
10.3.1 Synthetic long and short option and swap positions 207
10.3.2 Multiple swap/option positions 214
10.3.3 Asset swaps, liability swaps, and callable/puttable asset swap
packages 231
10.3.4 Credit derivatives and synthetic credit positions 238
11 Risk, Legal, and Regulatory Issues 247
11.1 Introduction 247
11.2 Risk and financial controls 247
11.2.1 Market, liquidity and credit risk management 247
11.2.2 Internal financial and operational controls 248
11.2.3 Internal audit 249
11.3 Legal controls 249
11.3.1 ISDA documentation framework 250
11.4 Regulatory and accounting issues 255
11.4.1 Regulatory capital 255
11.4.2 Regulatory review 257
11.4.3 Accounting treatment under FAS 133 and IAS 39 257
Selected References 261
Index 263