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Credit derivatives are transforming the fixed-income marketplace and putting greater demands on analysts. Here are the researchers who more than meet the challenge.
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Rising interest rates notwithstanding, debt markets have been uncharacteristically calm, while the lives of fixed-income analysts have been anything but. One development lies behind both outcomes: the growing popularity of credit derivatives. Increasing demand for these instruments the notional value of contracts outstanding exceeds $17 trillion, up from virtually zero just one decade ago is making analysts' jobs more challenging. Credit derivatives, which essentially offer investors protection against companies' defaulting on their debt, are increasingly being used as part of complex strategies by hedge funds and other institutions. Analysts, consequently, must understand this market and its impact on the corporate bonds they cover to provide truly comprehensive advice to clients. Surging derivatives use has even been a factor in some banks' decisions to restructure their research departments. Many firms have assigned analysts to roles on their trading desks, where they work internally with traders and advise just a handful of important clients. Others are merging previously separate departments within research, for example combining equity and fixed-income coverage.
The phenomenon's effect on debt markets has been far more benign. Events that not long ago would have caused ructions interest rate hikes, rising oil and commodities prices, equity volatility and geopolitical turbulence have created barely a ripple this year. As of mid-August the yield on the benchmark ten-year U.S. Treasury note sat comfortably at 4.9 percent, only slightly above its 4.4 percent resting place one year earlier, despite predictions that concerns about the economy would drive bond prices down much further.
"There are more tools these days for people to express and hedge their positions, especially with the growing use of credit derivatives," says Daniel Spina, head of fixed-income research for Bear, Stearns & Co. in New York. "Managers are much more experienced at handling event risk than in the past, having faced many unique and shocking events over the past several years."
One such event was last year's turmoil in the auto industry, which appears to have been the tipping point for the transition of credit derivatives from a niche product into the mainstream. In May 2005,...