Basic question but can someone explain the following statement"For a delta hedged long equity portfolio an increase in all CDS spreads together implies a lower delta"In particular why does it imply lower delta??

Basically, shifting all credit spreads wider has the impact of decreasing the equity tranche Deltas for each individual credit, but increasing the senior tranche Deltas for each individual credit. This is because shifting all credit spreads wider simultaneously has the impact of decreasing the probability of a small number of losses (lowering the relative risk of the equity tranche), whilst increasing the probability of a larger number of losses (increasing the relative risk of the senior tranche). The mezzanine tranche Deltas are less impacted.Similarly, when all credit spreads in the underlying portfolio are shifted tighter then the equity tranche Delta increases for each individual credit and the senior tranche Delta decreases for each individual credit. This is because shifting all credit spreads tighter simultaneously has the impact of increasing the probability of a small number of losses (increasing the risk of the equity tranche), whilst decreasing the probability of a larger number of losses (decreasing the risk of the senior tranche). The mezzanine tranche Deltas are less impacted.

Cool that makes sense...I knew it was a basic answer!!Thanks

when people talk about the price and premium on CDOs what do they mean by each?e.g "..Price a 0-7% tranche as a combination of the 0-3% and the 3%-7% assuming both tranches have a premium equal to the 3%-7% market premium..."I assume by price they mean spread but what is meant by the market premium??

By Market Premium we usually mean the Spread of the Tranche.The Price is a proxy for the MtM (Mark to Market) of the Tranche : In theory, the "Market Spread" is the spread paid such that the MtM value of the Tranche is 0. But when parameters move (Spreads of the underlying CDS, Correlation, ...) the "Market Spread" also moves (it can be higher or smaller) and therefore the MtM of the tranche changes : if the spread at which you entered the trade yesterday was S0 and today after a move in correlation (for example) if you wanted to unwind your position the spread is S, then your MtM = +/- (S - S0) x Risky_Duration (not 0 anymore !)I hope it's clear

nice one macfly..thats cleared it up...Heres my next basic questionSay I go long the equity tranche of a CDO and I delta hedge this with the CDS’s of the CDO. Then to work out the net MTM is it MTM of the equity tranche - MTM of the hedging portfolio?My second related question is this..All spreads on the CDS increase together which implies a lower delta. Hence delta for the tranche falls and hence the tranche is overhedged…Since the spreads have increased together the MTM in the equity tranche increases as does that of the hedging portfolio, but since I’m overhedged the hedging portfolio should increase more. In which case is my net MTM is negative?? Is this correct?? And if not what’s wrong with the logic..

I assume that when you say "I go long the equity tranche of a CDO" you mean long PROTECTION and short RISK" (if this is the contrary just take the opposite of everything I will say !)QuoteHeres my next basic questionSay I go long the equity tranche of a CDO and I delta hedge this with the CDS’s of the CDO. Then to work out the net MTM is it MTM of the equity tranche + MTM of the hedging portfolio?Yes if you buy protection on a Equity tranche and delta-hedged it buy shorting CDS on the underlyings, assuming your rebalanceyour deltas to lock in the profits (or the losses) then tou're right this is your MtM.QuoteMy second related question is this..All spreads on the CDS increase together which implies a lower delta. Hence delta for the tranche falls and hence the tranche is overhedged…Since the spreads have increased together the MTM in the equity tranche increases as does that of the hedging portfolio, but since I’m overhedged the hedging portfolio should increase more. In which case is my net MtM is negative?? Is this correct?? And if not what’s wrong with the logic..NO, considering you buy protection on the equity tranche and delta-hedge it by shorting some CDS, then if all the spreads of the underlying have increased together, YOUR MTM in the equity tranche is POSITIVE as the new market spread of the tranche would be higher. As for the delta hedge portfolio, your MtM is NEGATIVE since you have sold protection at lower spreads than today's spreads.Thus in that case, as for a uniform shift in spreads, the equity tranche is more convex than its delta-hedge, your MtM on the Equity is less positive than your MtM on your delta-hedge is NEGATIVE, which will result in a net NEGATIVE P&L.In one sentence, on this trade (Long Protection on the Equity delta-hedged) you are Gamma Negative --> UnderhedgedLet me know if this is clear for you ....

thanks.......What I meant to say was that I was selling protection on the equity tranche and delta hedging it by buying protection on the CDS..Is the first part still correct??For the second part then I assume MTM in equity tranche is Negative while MTM of the delta hedge is Positive in which case is net P&L negative??

QuoteOriginally posted by: playerthanks.......What I meant to say was that I was selling protection on the equity tranche and delta hedging it by buying protection on the CDS..Is the first part still correct??Sorry your total MtM is = MtM (Delta-Hedge Portfolio) + MtM (Equity Tranche) knowing that these MtM can be negativeQuoteFor the second part then I assume MTM in equity tranche is Negative while MTM of the delta hedge is Positive in which case is net P&L negative??In that case (selling protection on the equity tranche and delta hedging it by buying protection on the CDS) you're Gamma Positive. Here's below a summary :------------------------------------------------------------All Spreads Widen Sell Protection on Equity Tranche----------------- > - MTM Buy CDS (Delta notional)--------------------------- > + MTM Change in Delta of All Credits--------------------- > - Average Delta Over Spread Movement---------- > -Effective Delta Hedge ------------------------------ > Overhedged Net P&L (or net MTM)-------------------------------- > + MTM------------------------------------------------------------All Spreads TightenSell Protection on Equity Tranche ----------------- > + MTM Buy CDS (Delta notional)----------------------------> - MTMChange in Delta of All Credits------------------------ > +Average Delta Over Spread Movement------------- > +Effective Delta Hedge---------------------------------- > UnderhedgedNet P&L (or net MTM)---------------------------------- > + MTMHope this helps ....

nice one..that makes sense...I think the first point regarding the Net MTM was the main problem I was having...thanks again M