Introduction to the Credit Derivative Indices

[Pages:13]Introduction to the Credit Derivative Indices

Dow Jones CDX & iTraxx

August 2005

Contents

1

Introduction

2

Dow Jones CDX Index

Markit Group's Role

2

Members of CDS IndexCo LLC

2

DJ CDX Index Characteristics

3

DJ CDX North America High Yield Index

3

DJ CDX North America Investment Grade Index

3

DJ CDX Emerging Market Index

3

DJ CDX Emerging Market Diversified Index

4

DJ CDX Index Daily Fixing Process & Calculation Rules:

5

(An Excerpt from "Index Methodology for the Dow Jones CDX Indices")

iTraxx Index

Markit Group's Role

7

iTraxx Index Characteristics

7

iTraxx Europe Index

7

iTraxx Credit Japan Index

8

iTraxx Australia Index

8

iTraxx Asia ex-Japan Index

8

RED & Credit Indices

9

Investing in CDS Form

9

Credit Index Annex

10

1

Introduction

The Dow Jones CDX and iTraxx Indices have become the de facto benchmarks for credit investors. Static portfolios of credit default swaps serve as highly diversified and liquid tools and trade on standardized documentation. As investor appetite for the index product has increased, so has the need for detailed information on the DJ CDX and iTraxx Indices. This document is an introductory guide to the Dow Jones CDX and iTraxx Indices discussing some of the most frequently asked questions.

As the dealer appointed administrator of the DJ CDX Indices and full data set provider on the DJ CDX and the iTraxx Indices, Markit Group provides composite & theoretical data points with easy drill-down into index constituents, composite price levels, history and RED codes. To find out more, go to .

1. Dow Jones CDX Index Family

Markit's Role as the Administrator & Calculation Agent

Markit works closely with 16 of the largest North American credit derivative trading desks (CDS IndexCo LLC) in the selection of the underlying credits and also in the management of the details of the credit derivative indices.

As the administrator, some of Markit's key roles are:

? Conduct all dealer polls regarding the selection of the underlying credits ? Select underlying reference obligations following the selection of the reference entities (RED) ? Conduct polls on coupon fixings (applicable only to HY and EM indices) ? Publish & maintain the official credit index annexes (available for public access on

)

As the calculation agent, some of Markit's key roles are:

? Daily collect end-of-day prices from over 15 institutions ? Calculate and publish composite price & spread as well as theoretical price & spread on



? Release the official composite price & spread to Dow Jones for publication to The Wall Street Journal

Members of the CDS IndexCo LLC

ABN Amro Bear Stearns Goldman Sachs

Merrill

Barclays Citigroup

HSBC Morgan Stanley

BNP Paribas CSFB

JP Morgan UBS

Bank of America Deutsche Lehman Wachovia

? Each desk in North America contributes index levels by 5PM for the 4 main indices ? Voter Eligibility: Between each series, a dealer must have reached 85% contribution rate in order to

participate in the polling process of the subsequent roll. This rule encourages continuous data

contribution from each trading desk.

2

DJ CDX Index Characteristics

Index Name DJ CDX NA High Yield

# of Ref Entities

100

DJ CDX NA Investment

125

Grade

DJ CDX NA Investment

30

Grade HiVol

(sub-index of DJ CDX IG)

DJ CDX Emerging Market 14

DJ CDX Emerging Market 40 Diversified

Coupon 360 40 90

210 160

Effective Date

4/14/2005

Term 5 & 10

3/21/2005 1,2,3,4,5,7 & 10

3/21/2005 1,2,3,4,5,7 & 10

Maturity

6/20/2010 (5Y)

6/20/2010 (5Y)

6/20/2010 (5Y)

3/21/2005 4/4/2005

5 & 10 5 & 10

6/20/2010 (5Y)

6/20/2010 (5Y)

A. DJ CDX North America High Yield Index

*DJ CDX NA High Yield (main) DJ CDX NA High Yield B DJ CDX NA High Yield BB DJ CDX NA High Yield High Beta

The components of the sub-indices are derived from the DJ CDX NA HY mainline index.

Portfolio Composition

? Static portfolio of 100 equally weighted high yield CDS entities domiciled in North America ? Index constituents are based on votes from eligible CDS members ? Index administered and calculated by Markit daily ? New series of DJ CDX HY issued every 6 months (March & September) and the underlying

reference entities are reconstituted based on member votes

? Standard maturities will be 5 and 10 years for the notes and swaps

B. DJ CDX North America Investment Grade Index

*DJ CDX NA IG 125 (mainline) DJ CDX NA IG Consumers DJ CDX NA IG Industrials DJ CDX NA IG Energy DJ CDX NA IG HiVol (High Volatility) DJ CDX NA IG Financials DJ CDX NA IG TMT (Telecom, Media)

The components of the sub-indices are derived from the DJ CDX NA IG mainline index.

Portfolio Composition

? Static portfolio of 125 equally weighted investment grade CDS entities domiciled in North America ? Index constituents are based on votes from eligible CDS members ? Index administered and calculated by Markit daily ? New series of DJ CDX NA IG issued every 6 months (March & September) and the underlying

reference entities are reconstituted based on member votes

? Standard maturities will be 1,2,3,4,5,7 & 10 years for the notes and 5 and 10 years for the swaps

3

C. DJ CDX Emerging Market Index: No sub-indices Portfolio Composition ? Static portfolio of 14 equally weighted emerging market sovereign issuers ? Index constituents are based on votes from eligible CDX members ? Index administered and calculated by Markit daily ? New series of DJ CDX EM issued every 6 months (March & September) and the underlying reference entities are reconstituted based on member votes ? Standard maturities will be 5 and 10 years for the notes and 5 and 10 years for the swaps

D. DJ CDX Emerging Market Diversified Index: No sub-indices Portfolio Composition ? Static portfolio of 40 EM sovereigns and corporates ? Index administered and calculated by Markit daily ? New series of DJ CDX EM DIV issued every 6 months (March & September) and the underlying reference entities are reconstituted based on member votes

4

Dow Jones CDX Index Daily Fixing Process and Calculation Rules1

For each Covered Index, the Administrator will solicit closing mid prices from all Members that elect, as provided in the General Rules, to participate with respect to such Covered Index (a "Participating Member"). These prices will be submitted either by spreadsheet (or any other electronic delivery format designated as acceptable by the Administrator) or, later, via the Administrator's automated mechanism between 4:00 p.m. and 5:00 p.m. each day other than Saturday, Sunday, and United States Federal Holidays; provided that on any day that the Bond Market Association recommends closing the fixed income markets early, prices will be submitted within thirty (30) minutes after the time set by the Bond Market Association for the closing of the fixed income markets. The Administrator will publish a list of Participating Members with respect to each Covered Index set forth below. A Member will be removed from such published list for a Covered Index during any period for which it has been Suspended with respect to such Covered Index in accordance with the Eligibility Rules.

The Administrator will employ a filtering process which mirrors that used by the British Banker's Association to calculate LIBORs. This entails taking the received quotes, discarding the top and bottom quartiles and taking the mean of what remains. The number of points q in each discarded quartile will be given by q=int(Nc/4) where Nc is the total number of contributors. Examples are shown in the table below:

Table of Discarded Quartile Examples

Number of Contributors

1

Upper Quartile Discards 0

3

0

4

1

5

1

7

1

8

2

11

2

12

3

15

3

16

4

19

4

20

5

Lower Quartile Discards 0

0

1

1

1

2 2 3 3 4 4 5

Number of Quotes used in Fixing

No fixing calculated

No fixing calculated

2 but fixing only calculated where minimum acceptable no = 4

3 but fixing only calculated where minimum acceptable no ................
................

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