Mastering Credit Derivatives: A step-by-step guide to credit derivatives and structured credit, Second Edition

Chapter 7. First-to-default (FTD) baskets

While the lion’s share of attention and liquidity in the tranched credit markets is focused on cash CDOs (see Chapter 8), synthetic CDOs (see Chapter 9), and the tranched indices (see Chapter 5), first-to-default baskets or, more generally, nth-to-default baskets are the simplest tranched credit instrument. First-to-default baskets look similar to a credit default swap, but the uncertainty associated with whether a credit in the basket will trigger a credit event makes the risk and return profile intuitively more similar to CDO tranches. There are important differences as well, which this chapter will address.

Basket Default Swap Mechanics

An nth-to-default basket product is one in which the investor gains ...