Hi,My question is does a CDS spread of a corporate say CDS on an Italian auto maker, takes into account the soverign risk, i.e., the risk that Italy will default is embedded in that auto maker's CDS spread being quoted by the market. If not then if pricing a foreign currency note, should I need to add soverign spread.

But you are not exposed to sovereign risk when you hold the automaker paper. Just the automaker risk.

is this a USD CDS contract where the dleiverable is a Euro bond ?

So if I am trying to value a forign currency denominated debt of the company I need to add the soverign CDS spread alongwith the corporate CDS spread?

Its an FCCB and my question is arrive at the credit spread of the company, yeah the FCCB is in USD

QuoteOriginally posted by: nikhilessarHi,My question is does a CDS spread of a corporate say CDS on an Italian auto maker, takes into account the soverign risk, i.e., the risk that Italy will default is embedded in that auto maker's CDS spread being quoted by the market. If not then if pricing a foreign currency note, should I need to add soverign spread.it sure does!

QuoteOriginally posted by: nikhilessarHi,My question is does a CDS spread of a corporate say CDS on an Italian auto maker, takes into account the soverign risk, i.e., the risk that Italy will default is embedded in that auto maker's CDS spread being quoted by the market. If not then if pricing a foreign currency note, should I need to add soverign spread.I would say that it depends whether the CDS is priced correctly by the market. It could be mispriced and not take sovereign risk into account.

QuoteOriginally posted by: islingtonBut you are not exposed to sovereign risk when you hold the automaker paper. Just the automaker risk.no way. do you think the automaker can pay its debt while Italy is going bankrupt?

QuoteOriginally posted by: almostcutmyhairQuoteOriginally posted by: islingtonBut you are not exposed to sovereign risk when you hold the automaker paper. Just the automaker risk.no way. do you think the automaker can pay its debt while Italy is going bankrupt?An individual company can have better debt balance and credit worthiness than the sovereign entity of the country. It's rare but it does happen.

QuoteOriginally posted by: HansiQuoteOriginally posted by: almostcutmyhairQuoteOriginally posted by: islingtonBut you are not exposed to sovereign risk when you hold the automaker paper. Just the automaker risk.no way. do you think the automaker can pay its debt while Italy is going bankrupt?An individual company can have better debt balance and credit worthiness than the sovereign entity of the country. It's rare but it does happen.it should be a highly international company

QuoteOriginally posted by: almostcutmyhairQuoteOriginally posted by: HansiQuoteOriginally posted by: almostcutmyhairQuoteOriginally posted by: islingtonBut you are not exposed to sovereign risk when you hold the automaker paper. Just the automaker risk.no way. do you think the automaker can pay its debt while Italy is going bankrupt?An individual company can have better debt balance and credit worthiness than the sovereign entity of the country. It's rare but it does happen.it should be a highly international companyYes in almost all instances of seeing such effect that has been the case.

Ok, so if the company cannot pay if the sovereign paper defaults it just means that the risks are correlated. But the CDS hedges you against the company default. If it is written in local currency then you have a funny contingent FX risk which you may proxy hedge with a sovereign CDS, but you are not exposed to sovereign credit risk.The correlation argument would make you buy index puts on top of single stock puts because 'there is no way the stock won't go south when the market drops'.

QuoteOriginally posted by: nikhilessarHi,My question is does a CDS spread of a corporate say CDS on an Italian auto maker, takes into account the soverign risk, i.e., the risk that Italy will default is embedded in that auto maker's CDS spread being quoted by the market. If not then if pricing a foreign currency note, should I need to add soverign spread.Graph the automarket CDS prices with Italy's CDS and you'll get the answer.

QuoteOriginally posted by: islingtonOk, so if the company cannot pay if the sovereign paper defaults it just means that the risks are correlated. But the CDS hedges you against the company default. If it is written in local currency then you have a funny contingent FX risk which you may proxy hedge with a sovereign CDS, but you are not exposed to sovereign credit risk.The correlation argument would make you buy index puts on top of single stock puts because 'there is no way the stock won't go south when the market drops'.The premium you pay for the swap on the automaker's debt is compensating the counterparty for facing systematic risk. That is the same risk you'd face when holding sovereign debt, though default on the latter would have far more systemic impact. CDS on an italian automarker is implicitly pricing in the possibility of italy defaulting, there's really no sense in adding anything on top of that (assuming FX exposure is hedged)... unless you'd want to hedge your counterparty exposure in case of a sovereign default (i.e. the person selling you the swaps will fold if italy defaults).

QuoteOriginally posted by: halikQuoteOriginally posted by: islingtonOk, so if the company cannot pay if the sovereign paper defaults it just means that the risks are correlated. But the CDS hedges you against the company default. If it is written in local currency then you have a funny contingent FX risk which you may proxy hedge with a sovereign CDS, but you are not exposed to sovereign credit risk.The correlation argument would make you buy index puts on top of single stock puts because 'there is no way the stock won't go south when the market drops'.The premium you pay for the swap on the automaker's debt is compensating the counterparty for facing systematic risk. That is the same risk you'd face when holding sovereign debt, though default on the latter would have far more systemic impact. CDS on an italian automarker is implicitly pricing in the possibility of italy defaulting, there's really no sense in adding anything on top of that (assuming FX exposure is hedged)... unless you'd want to hedge your counterparty exposure in case of a sovereign default (i.e. the person selling you the swaps will fold if italy defaults).I think you can still distill this contagion effect from the CDS quotes or the CVA of your CDS.