Guide to Analysing Companies

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CREDIT CARD
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full. Despite attempts by regulators to standardise the basis on
which interest rates are quoted, it can still be hard to compare
one card with another.
Credit default swap
A bespoke derivative that allows the buyer to purchase a
form of insurance from the seller against the risk that a third
party will default on its payment. Suppose there are two
counterparties to a deal: a market maker and an investor.
They first decide on the asset that is to be the third party; for
example, a bond issued by a company or perhaps a sovereign
borrower. The market maker agrees to make regular payments
to the investor for two years (the life of the bond), each one co-
inciding with the interest payments received on the bond. If
the third party defaults at any time during the two years, then
the market maker would make the regular fixed payment to the
investor and hand over the bond in exchange for the equivalent
of the bond’s par value plus any remaining interest. Credit
default swaps are somewhere between a cash instrument and
a derivative and, believe it or not, are reckoned to be among the
most straightforward types of credit derivative.
Credit duration
A measure (expressed as a figure) of how long it takes to repay
a bond’s purchase price in present-day values. This depends on
a combination of the present value of its cash flows (both
interest and repayments of principal over the bond’s life),
the proportion of the bond’s current price that these cash flows
form and the period left to run before the bond matures. Bonds
with a low coupon (interest rate) generally have a longer du-
ration and are therefore more sensitive to changes in the rate
of interest. So when rates are volatile it may pay an investor
to choose a bond with a lower duration.