Credit —
from bonds to CDS.

Corporate bonds are debt securities issued by companies to raise capital, giving investors a fixed income stream in exchange for lending money to the issuer. The key structural terms are straightforward:

• Coupon: The fixed interest rate paid to bondholders, typically semi-annually. A 5% coupon on a £1,000 bond pays £25 every six months.
• Maturity: The date on which the issuer repays the principal (face value) in full. Most corporate bonds mature between 1 and 20 years, though 30-year issuance exists for large investment grade names.
• Face value / par: The principal amount, conventionally 100. A bond trading at 95 is at a discount; at 105, at a premium.
• Day count convention: Coupons are calculated on a 30/360 basis — meaning each month is treated as 30 days and the year as 360 days. This standardises coupon calculations across different calendar months.

Corporate bonds sit below government bonds in terms of credit quality but above equity in a company's capital structure. Investors accept higher risk than Treasuries in exchange for a spread above the risk-free rate — the credit spread.

Corporate bond pricing comes down to four interrelated factors:

1. Credit rating: The rating assigned by Moody's, S&P, or Fitch — from AAA (highest quality) down through investment grade to high yield — is the primary driver of the spread over government bonds. A downgrade immediately widens spreads and lowers the price.

2. Credit quality and financial health: The underlying fundamentals of the company — its leverage ratio (debt/EBITDA), interest coverage (EBITDA/interest expense), free cash flow generation, and industry dynamics. Ratings are backward-looking; the market prices in forward-looking credit deterioration or improvement before the agencies move.

3. Position in the capital structure: A senior secured bond on the same company will trade tighter (lower spread) than a subordinated or unsecured bond from the same issuer, because in a default the senior secured creditor recovers first against specific collateral. Where you rank in the waterfall directly affects expected recovery rates.

4. Comparable market pricing: New bonds are typically priced at a spread relative to where comparable bonds from similar issuers are trading. This "price talk" anchors the initial coupon, which the market then adjusts in secondary trading.

Overlaying all of this: the prevailing level of government bond yields, which set the risk-free rate floor, and general credit market conditions — tight spreads in a risk-on environment, wide spreads in risk-off.

The global corporate bond market — bonds, loans, and revolving credit facilities combined — is approximately $10 trillion in the US alone, with global totals significantly higher when including European and Asian corporate debt. It is the largest fixed income market after government bonds.

By credit quality, the market skews heavily toward investment grade. Most outstanding debt is rated BBB or above, reflecting both the size of large investment-grade issuers and the market's structural preference for IG paper from institutional buyers with rating-based mandates.

The biggest industry issuers are financials by far — banks and insurance companies issue enormous volumes of debt to fund their balance sheets, meet regulatory capital requirements, and refinance maturing obligations. Among non-financials, the largest sectors are utilities (capital-intensive infrastructure), telecoms (spectrum acquisitions, network buildout), and technology (acquisitions and share buybacks funded with cheap debt).

For the UK specifically, the gilt market and sterling corporate bond market are substantially smaller than their US equivalents, but highly liquid in IG. The European corporate bond market (denominated in euros) is a major market with Barclays, BNP Paribas, and Deutsche Bank as key market makers.

New corporate bonds are brought to market by the Debt Capital Markets (DCM) division of an investment bank — this sits in investment banking, not S&T, because DCM bankers have access to material non-public information about the issuer and cannot simultaneously trade the bonds. DCM teams advise the company on timing, structure, pricing, and investor marketing.

The issuance process: DCM selects a lead manager (or a syndicate of banks for large deals), determines "price talk" — the indicative spread range — and runs a bookbuilding process where institutional investors submit orders. Once the book is oversubscribed at a given spread, the deal prices and the bonds are allocated. For investment grade, this entire process can happen in a single morning. High yield deals typically involve a roadshow of several days.

Once issued, bonds trade in the secondary market — this is where S&T desks operate. IG credit traders make markets, provide liquidity, and enable investors to buy or sell bonds that were previously issued. Secondary markets are OTC (over the counter), not exchange-traded, meaning every transaction is negotiated between counterparties via phone or electronic platform (Bloomberg, MarketAxess).

The key distinction: DCM originates bonds once. S&T provides ongoing liquidity in those bonds for their entire life — which can be 10 or 20 years.

Companies choose between bonds, bank loans, and equity based on cost, flexibility, and strategic objectives.

Bonds vs bank loans: Bonds allow companies to access a much broader investor base — pension funds, insurance companies, and global asset managers who cannot provide bank loans. This diversification reduces dependence on any single lender and often allows larger amounts to be raised. Bonds are also typically less restrictive in their covenants than loans, particularly for investment grade issuers. The trade-off is that bonds are less flexible — once issued, the terms are fixed, whereas a bank loan can sometimes be renegotiated.

Bonds vs equity: Interest on debt is tax-deductible in most jurisdictions; dividends are not. This gives debt a tax advantage. Issuing equity also dilutes existing shareholders, which management typically wants to avoid if leverage is manageable. However, too much debt increases financial distress risk — hence the leverage ratio constraints in debt covenants.

The primary funding reasons are: financing acquisitions, refinancing existing debt at better terms, funding capital expenditure, and managing the maturity profile of the balance sheet.

Corporate bonds attract the broadest investor base in fixed income. The main buyers:

• Pension funds and insurance companies: The largest owners of IG corporate bonds. They need long-duration assets to match their long-duration liabilities (pension payments decades into the future). Corporate bonds offer yield above government bonds with manageable credit risk in IG.
• Asset managers and mutual funds: Run diversified fixed income funds on behalf of retail and institutional investors. They are active secondary market traders and are a major source of flow for credit desks.
• Hedge funds: More active in high yield and distressed credit, where mispricings are larger. They also trade credit derivatives and basis trades between bonds and CDS.
• Banks: Hold IG bonds on their own balance sheets for yield and liquidity, and through their trading desks maintain inventory of bonds to facilitate client flow.
• Sovereign wealth funds: Large buyers of IG, particularly for diversification from government bonds.

Not all buyers participate across the credit quality spectrum. Pension funds typically have mandates restricting them to investment grade — they cannot hold high yield. Distressed debt funds, conversely, specifically seek out sub-investment grade and defaulted bonds. The mandate structure of the buyer base significantly affects liquidity and pricing in each credit segment.

The credit spread is the difference in yield between a corporate bond and a government bond of the same maturity. It represents the additional compensation investors demand for taking on credit risk — the possibility that the company defaults and does not repay in full.

T+250 means the bond yields the current 10-year Treasury rate plus 250 basis points (2.5%). If the 10-year Treasury yields 4.3%, then the bond yields 6.8%. The "T+" notation is standard for US dollar bonds. For sterling bonds, you'll see "Gilts+" or "G+"; for euro bonds it's typically "MS+" (mid-swaps plus a spread).

Spreads are quoted in basis points (bps), where 1 bps = 0.01%. A tighter spread (smaller number) means the market perceives lower credit risk; a wider spread means higher perceived risk or lower liquidity. Investment grade bonds typically trade at T+50 to T+300, while high yield can range from T+300 to well over T+1000 for distressed credits.

Crucially, spreads are not static — they move with company-specific news, broader credit market conditions, and macro risk sentiment. A credit trader's job is to anticipate and capitalise on these spread moves.

Spreads widen (increase) when:

• Economic conditions deteriorate — recession fears raise default probabilities across the board
• The specific issuer shows signs of stress — earnings miss, leverage rising, covenant breach risk
• Credit markets are in risk-off mode — investors sell credit and buy government bonds as a safe haven
• Heavy new issuance supply — a large calendar of new bonds forces existing bonds to cheapen to attract buyers
• Ratings downgrade — particularly a fallen angel event (IG to HY) forces forced selling from IG-mandated funds

Spreads tighten (decrease) when:

• Strong economic data reduces default risk expectations
• The company deleverages or reports strong earnings
• Risk-on environments push investors into credit seeking yield above government bonds
• Central bank easing improves refinancing conditions and corporate balance sheets
• Low new issuance supply — demand exceeds supply, compressing spreads

In 2026, IG and HY spreads are historically tight, reflecting the soft-landing macro environment. The concern is complacency — tight spreads do not mean zero risk, particularly in private credit where stress is less visible.

The major rating agencies — Moody's, S&P, and Fitch — assess the creditworthiness of bond issuers and assign letter ratings. The rating process involves a detailed analysis of both business risk and financial risk:

Business risk: Industry position, competitive dynamics, revenue stability and predictability, management quality, and the regulatory environment. A utility with captive customers and regulated returns has lower business risk than a cyclical manufacturer.

Financial risk: The capital structure — leverage ratio (debt/EBITDA), interest coverage (EBITDA/interest expense), free cash flow, and liquidity. The agency will also look at how the company compares to peers on these metrics.

The rating scale (S&P/Fitch): AAA, AA+, AA, AA−, A+, A, A−, BBB+, BBB, BBB− are investment grade. Below BBB− is high yield (also called non-investment grade or "junk"). Moody's uses a parallel scale: Aaa, Aa1/Aa2/Aa3, A1/A2/A3, Baa1/Baa2/Baa3 (IG), then Ba1 and below (HY).

The BBB−/Ba1 boundary is the most important line in credit markets because it determines which institutional investor mandates can hold the bond. A bond falling below this line — a "fallen angel" — is forced selling territory.

IG and HY bonds are different markets in almost every practical dimension:

Quoting convention: IG bonds are typically quoted as a spread over government bonds of the same duration — e.g. "Gilts+80" or "T+120." The spread is the number that moves as credit conditions change. HY bonds are almost always quoted on an outright yield basis — e.g. "8.5%" — because the yield itself is what matters to buyers who are focused on income, and the government benchmark spread is less the focus.

Liquidity: IG is vastly more liquid. Large IG bond deals ($1bn+) can trade in size with narrow bid-ask spreads of 1–5bps. HY bonds trade with much wider bid-ask spreads — often 50–100bps for smaller, less liquid names — reflecting lower issuance sizes and fewer institutional buyers. A dealer's IG inventory is easier to hedge and turn over than HY.

Investor base: IG attracts pension funds, insurance companies, and real-money managers with investment grade mandates. HY is dominated by high yield mutual funds, hedge funds, and credit opportunity funds. This segment bifurcation means a fallen angel bond faces a structural supply/demand shock — IG sellers and HY buyers don't overlap cleanly.

New issuance: IG can price in hours. HY typically requires a roadshow and takes days, partly because HY investors require more due diligence and partly because deals are smaller and harder to distribute quickly.

A Fallen Angel is a bond that was originally issued as investment grade but has been downgraded below BBB−/Baa3 into high yield territory. The term captures the dramatic shift in how the bond is perceived — and crucially, how it must be held — once it crosses the IG/HY boundary.

Why Fallen Angels cause market disruption: many institutional investors — pension funds, insurance companies, certain mutual funds — have mandate restrictions that prohibit holding sub-investment grade bonds. When a bond is downgraded, these holders are forced to sell, regardless of their fundamental view on the company. This creates a supply shock in HY markets (new bonds entering a market not expecting them) and mechanical selling pressure that can push prices well below fundamental value.

Fallen Angels are also watched as leading indicators of broader credit stress. A wave of fallen angels — as occurred in 2020 during COVID — signals that corporate balance sheets are deteriorating and credit conditions are tightening. Conversely, "rising stars" (HY bonds upgraded to IG) signal improving credit quality and tightening of those specific bonds' spreads.

For credit traders and salespeople, fallen angel situations create trading opportunities — the forced selling often overshoots the fundamental value, creating potential recovery plays for HY investors willing to do the credit work.

An investment grade issuer — typically BBB to AA rated — will generally have:

• Low leverage: Net debt/EBITDA of 2–3x or below. IG issuers typically have headroom on their leverage ratios relative to the covenants in their debt documents.
• Strong interest coverage: EBITDA/interest expense of 5x or above. The company comfortably services its debt from operating cash flow even in a mild downturn.
• Predictable, recurring revenue: Utilities, telecoms, and consumer staples are natural IG sectors because their revenues are stable. Highly cyclical businesses — commodity producers, airlines — struggle to maintain IG ratings through economic cycles.
• Positive free cash flow: The company generates cash after capital expenditure, reducing dependence on capital markets for operational needs.
• Simple, transparent capital structure: IG issuers typically have limited secured debt and clear seniority in their bond stack. Complex structures with lots of layers of senior secured, second lien, and subordinated debt are more common in leveraged finance/HY.
• Access to diverse funding: IG issuers can tap public bond markets, bank revolvers, and commercial paper with ease. HY issuers have fewer options, especially in stressed markets.

The capital structure runs from most senior (first claim in a default) to most junior (last claim). From top to bottom:

• Revolving Credit Facility (RCF): Like a corporate credit card — drawn and repaid as needed. Typically secured against the company's assets and ranks highest in a default. Banks providing the revolver are first in line.
• Term Loan A (TLA): Amortising loan, usually held by banks. Senior secured.
• Term Loan B (TLB): Bullet maturity (repaid in full at end), syndicated and actively traded on the secondary market by the bank loan desk. Also senior secured but slightly subordinate to TLA in many structures.
• Senior Secured Notes: Bonds with a claim on specific company assets. First-lien status means they recover first in a restructuring.
• Senior Unsecured Notes: Bonds with no claim on specific assets — they rank behind secured creditors in a default but ahead of subordinated debt. Most IG corporate bonds are senior unsecured.
• Subordinated / Junior Notes: Expressly junior to senior debt. Higher coupon to compensate for lower recovery in a default.
• Mezzanine Debt: Hybrid instruments — sometimes convertible into equity — sitting just above equity in the structure. Very high yield, high risk.
• Preferred Equity: Claims on dividends and assets before common equity but after all debt.
• Common Equity: Last claim. Zero recovery in a typical corporate bankruptcy.

The further down the structure, the higher the expected yield (compensation for lower recovery probability) and the higher the credit risk.

Covenants are contractual restrictions written into the debt documents (indenture for bonds, credit agreement for loans) that constrain what the company can and cannot do during the life of the debt. They protect creditors by limiting actions that could impair the company's ability to repay.

There are two broad types:

Negative covenants (the most common in bonds) restrict the company from taking certain actions without lender consent. Examples:

• Leverage covenant: Maximum debt/EBITDA ratio — ensures the company doesn't pile on more debt than the existing creditors agreed to underwrite
• Coverage covenant: Minimum EBITDA/interest expense — ensures cash flow can service the debt
• Negative pledge: Prohibits the company from pledging specific assets as collateral for new debt, protecting existing unsecured creditors from being subordinated by stealth
• Restricted cash: Minimum liquidity that must be maintained
• Limitations on asset sales: Prevents stripping out valuable assets without applying proceeds to debt repayment
• Restricted payments: Limits dividends and share buybacks if leverage exceeds a threshold

Positive / affirmative covenants require the company to do things — maintain insurance, provide financial statements, notify lenders of material events.

A covenant breach triggers a technical default, giving creditors the right to accelerate repayment or negotiate a waiver. HY bonds have more covenants than IG (tighter restrictions on riskier issuers); loans have more covenants than bonds.

HY bonds have more covenants than IG bonds. This reflects the credit risk differential. IG issuers are considered strong enough that investors accept lighter documentation — many IG bonds are "covenant-lite" by HY standards. HY issuers, being riskier, require tighter restrictions to protect investors from value-destructive actions that the company might otherwise take to benefit equity holders at creditors' expense.

Loans have more covenants than bonds. This is partly because loan documentation is negotiated privately between a company and its banking syndicate (allowing more customisation) and partly because banks, as relationship lenders, want ongoing monitoring rights and the ability to intervene early if the company deteriorates. The bank loan covenant package — including maintenance covenants tested quarterly — gives lenders earlier warning and greater control than bond documentation typically allows.

An important nuance: even when loans technically have more covenants, lenders frequently waive or amend them if a company gets into trouble, rather than forcing a technical default that might not serve anyone's interests. "Covenant-lite" loan structures (without maintenance financial covenants) have become increasingly common in leveraged loans, somewhat eroding this distinction.

The two foundational ratio types in credit analysis are:

Leverage ratios — measure how much debt the company carries relative to its earnings:

• Debt / EBITDA (gross leverage)
• Net Debt / EBITDA (net leverage — subtracts cash holdings)
• Debt / (EBITDA − capex) — a more conservative measure that accounts for maintenance capital requirements

Coverage ratios — measure whether the company generates enough cash to service its debt:

• EBITDA / Interest Expense (interest coverage ratio)
• Free Cash Flow / Total Debt Service (cash coverage)

Reference ranges that matter: for investment grade, you would typically want to see net leverage below 3x and interest coverage above 5x. For high yield, leverage of 4–6x is common, with coverage of 2–3x. Leverage above 7x or coverage below 2x starts to raise distress concerns for most credits.

These numbers are also embedded in covenants — a leverage covenant at 4.5x means the company cannot let its debt/EBITDA exceed that level without triggering a technical default or requiring a waiver from lenders.

A credit trader holding a corporate bond is exposed to two distinct risks: interest rate risk (the bond's price moves as government yields change) and credit risk (the spread moves as the company's creditworthiness changes). These are hedged separately.

Interest rate risk — hedged with government bond futures or swaps: A corporate bond's duration means it will lose value if rates rise. To neutralise this, a trader will short an equivalent DV01 amount of Treasury or gilt futures (or pay fixed in an interest rate swap). After hedging, the position is "spread duration" only — it profits if the credit spread tightens and loses if it widens, but is neutral to outright rate moves.

Credit risk — hedged with Credit Default Swaps (CDS): If a trader holds a bond but wants to reduce credit exposure without selling the bond (perhaps for liquidity or relationship reasons), they can buy CDS protection on the same name. The CDS pays out if a credit event occurs, offsetting losses on the bond. This creates an "asset swap" position — essentially earning the spread between the bond yield and the CDS premium.

In practice, IG credit traders hedge interest rate risk routinely and hold credit risk as their primary P&L driver. HY traders tend to carry more outright credit risk, given CDS liquidity is thinner for smaller names.

A callable bond gives the issuer the right (but not the obligation) to redeem the bond early — before maturity — at a predetermined call price, typically at or above par. Most modern HY bonds and many IG bonds are callable after an initial non-call period.

Why issuers like callable bonds: If interest rates fall after issuance, the company can call the existing bonds (paying the call price) and reissue new debt at a lower coupon, reducing their interest burden. This is analogous to a homeowner refinancing a mortgage when rates drop. Without the call option, the company would be locked into a higher coupon for the bond's full life.

Why investors accept callables: They don't accept them for free — callable bonds offer a higher coupon than equivalent non-callable bonds. This "call premium" compensates investors for the reinvestment risk: if the bond is called when rates are low, investors receive their money back but must reinvest at lower prevailing rates. The call price (e.g. 103 — meaning the company pays £103 per £100 face value) also provides some compensation above par.

The call schedule matters: a typical HY bond might have a non-call period of 3 years, then callable at 104, 103, 102, 101, and par from year 4 to year 7. This creates a "make-whole call" provision at a premium during the non-call period if the company wants to refinance early.

A puttable bond gives the investor the right to demand early repayment from the issuer at a predetermined put price (usually par). It is the mirror image of a callable bond — instead of the issuer having the option, the investor holds it.

Investors would exercise the put option when interest rates have risen since issuance, making the existing bond less attractive. By putting the bond back to the issuer at par, they recover their principal and can reinvest at the now-higher prevailing rates.

Puttable bonds are far less common than callable bonds, for a practical reason: they create significant cash flow uncertainty for the issuer. If rates rise sharply, a large proportion of puttable bondholders may simultaneously exercise their put options, forcing the company to find large amounts of cash to repay them — potentially at exactly the worst time (rising rates often correlate with tightening credit conditions). Companies therefore prefer to avoid this contingent liability.

Where puttable bonds do appear, they typically carry a lower coupon than equivalent non-puttable bonds, reflecting the value of the put option to the investor.

A convertible bond (CB) is a corporate bond that gives the investor the right to convert the bond into a predetermined number of the company's shares at a fixed conversion price. The number of shares received per bond is the conversion ratio; the current value of those shares is the parity or conversion value.

The embedded option: A convertible bond has a call option on the company's equity embedded within it. This call option cannot be stripped out and traded separately — it can only be exercised by converting the bond into shares. The option has value that grows if the company's share price rises toward (or above) the conversion price, at which point converting becomes economically attractive.

Why companies issue CBs: The embedded equity upside allows the company to pay a lower coupon than a straight bond — investors accept less income in exchange for potential equity participation. The coupon savings can be significant. Additionally, if the share price rises enough that investors convert, the company effectively issues equity without the dilution of a straight equity offering at that moment (and avoids the deal costs).

Why investors buy CBs: The bond floor provides downside protection — even if the embedded call expires worthless (share price stays below conversion price), the investor holds a conventional bond that pays coupons and repays principal. The call option provides equity-like upside if the company performs well. It's a "heads I win more, tails I lose less" structure vs outright equity.

Convertibles typically sit slightly above straight bonds in terms of coupon (they're senior to equity) but below straight bonds in terms of yield (the equity option lowers the required coupon).

Despite the name, Eurobonds have nothing to do with the Euro currency. A Eurobond is simply a bond issued outside the domestic market of the issuer and denominated in a currency other than the issuer's home currency. The "Euro" prefix is historical — it dates to the 1960s when US companies began issuing dollar-denominated bonds in European markets to avoid US regulations.

In practice, "Eurobond" describes the international bond market — bonds issued by multinationals, governments, and supranationals (e.g. the World Bank) in a currency and jurisdiction different from their home market. A Japanese company issuing yen bonds in London is issuing a Eurobond; a US company issuing dollar bonds in London is also issuing a Eurobond.

Eurobonds are typically issued in bearer form (historically), are settled through clearing systems like Euroclear or Clearstream, and are subject to the regulations of the jurisdiction of listing rather than the issuer's home country — which historically made them attractive for tax efficiency and regulatory arbitrage.

For UK markets, the London-listed Eurobond market is large and significant — many international companies prefer to list bonds in London for flexibility and investor access.

Expected loss (EL) is a fundamental credit concept: it is the product of the probability of default (PD) and the loss given default (LGD).

EL = PD × LGD

Where LGD = 1 − Recovery Rate. If a bond has a 5% probability of defaulting in a year and an expected recovery of 40 cents on the dollar in a default, then LGD = 60%, and expected loss = 5% × 60% = 3%.

This expected loss needs to be compensated by the credit spread. A rational investor demands a spread at minimum equal to the expected loss — plus additional compensation for the uncertainty around that loss (the risk premium). This is why higher-risk bonds (higher PD, lower recovery) trade at much wider spreads.

Recovery rates vary significantly by where a bond sits in the capital structure. First-lien secured loans typically recover 60–80 cents on the dollar. Senior unsecured bonds recover 30–50 cents. Subordinated bonds recover far less. This is why capital structure seniority affects pricing so directly — it is not just seniority for its own sake, it is a direct driver of expected recovery and therefore expected loss.

A Credit Default Swap (CDS) is a bilateral derivative contract that functions like insurance on a specific borrower's creditworthiness. There are two parties:

Protection buyer: Pays a fixed periodic premium (the CDS spread, quoted in basis points per annum) and receives a payment if a "credit event" occurs on the "reference entity" (the borrower being referenced). The protection buyer is effectively short the credit — they profit if the borrower deteriorates or defaults.

Protection seller: Receives the premium payments and must make a large payment if a credit event occurs. They are long the credit — they profit from receiving premiums as long as the company stays solvent.

The payment in a credit event compensates the buyer for the loss on the underlying bond: if the reference entity defaults and its bonds fall to 40 cents on the dollar, the CDS pays out 60 cents per pound of notional (par minus recovery value).

Credit events are formally defined in ISDA documentation and typically include: bankruptcy, failure to pay, and (for some reference entities) debt restructuring.

CDS trade actively in the secondary market and their spread changes as credit conditions change — rising when the market perceives higher default risk, falling when the credit improves. This means CDS can be used as a pure credit trade, without needing to own or short the underlying bond.

Yes — CDS are actively traded in the secondary market and their value changes constantly without any default occurring. The CDS spread reflects the current market assessment of default probability, which fluctuates as company-specific and macro conditions change.

If a company's credit deteriorates — earnings miss, leverage rising, sector stress — the CDS spread widens. The protection buyer who entered at a tight spread now holds a contract worth more (because protection has become more expensive to buy), and can sell the CDS at a profit without ever experiencing a default. Conversely, if the company improves, spreads tighten and the protection seller profits.

A famous example: Goldman Sachs bought billions of dollars of CDS protection on AIG in 2005–2007, when AIG's credit was considered very strong and protection was cheap. As AIG's credit deteriorated in 2007–2008, the CDS spread widened dramatically — Goldman's position gained enormous value, and they were eventually paid out in full when AIG's credit event occurred. The CDS was not just insurance at maturity — it was a live, mark-to-market position.

CDS indices — most notably CDX (US) and iTraxx (Europe) — allow investors to buy protection on a basket of reference entities, providing efficient macro credit exposure without needing to trade individual names.

When a credit event is formally determined (by a process governed by the ISDA Credit Derivatives Determinations Committee), CDS contracts settle in one of two ways:

Physical settlement: The protection buyer delivers eligible reference obligations (typically bonds of the defaulted entity, which now trade at deeply distressed prices — e.g. 30 cents on the dollar) to the protection seller. The protection seller then pays the buyer par value (100 cents) in cash. The buyer effectively bought the bonds cheaply in the market, delivers them, and receives par — pocketing the difference between par and the distressed purchase price.

Cash settlement (now the standard): An auction process is run by ISDA to determine the fair market value of the defaulted bonds. If the auction settles the reference bonds at 35 cents on the dollar, the CDS seller pays the buyer 65 cents per pound of notional (par minus auction price). No physical delivery of bonds is required. Cash settlement is now the market standard because it eliminates "cheapest to deliver" gaming and is cleaner to administer across thousands of CDS contracts referencing the same entity.

The auction settlement price becomes the benchmark recovery rate used across all CDS contracts — creating a clean, standardised resolution even for complex credit events.

1. Speculation on credit deterioration: A distressed debt hedge fund that believes a company is heading toward financial difficulty can buy CDS protection without owning any of the company's bonds. If the credit deteriorates and CDS spreads widen, the fund profits by selling the protection at the new, wider level. This is a pure credit short — cheaper and more efficient than short-selling bonds (which requires borrowing).

2. Hedging existing exposure: A corporate treasury or bank that has extended credit to a company — through trade credit, a loan, or an ongoing business relationship — can buy CDS as insurance against the counterparty defaulting. A bank that has lent £200m to a company can buy £200m of CDS protection: if the company defaults, the CDS payout offsets the loan losses. This is common at large banks managing concentrated credit risk to key counterparties.

3. Hedging sector exposure without selling specific bonds: A large asset manager with significant exposure to the energy sector in their credit portfolio might not want to sell individual bonds (due to illiquidity, relationship reasons, or tax) but wants to reduce that sector exposure ahead of a negative macro catalyst. They can buy CDS on a basket of energy names or use the CDX HY index to put on a broad credit hedge, creating downside protection without disturbing their physical bond positions.

Credit encompasses a wide range of products spanning the full risk spectrum:

• Investment grade corporate bonds — liquid, tight spreads, large institutional buyer base
• High yield bonds — higher spreads, more restricted covenants, smaller and less liquid
• Leveraged loans / Term Loan B — floating rate, senior secured, actively traded by the bank loan desk
• Distressed bonds and loans — sub-50 cents on the dollar, often in or near restructuring
• CLOs (Collateralised Loan Obligations) — securitisations of leveraged loans, tranched by risk
• Credit Default Swaps (CDS) — single-name and index (CDX/iTraxx)
• Credit indices — CDX IG, CDX HY, iTraxx Europe, iTraxx Crossover
• Convertible bonds — hybrid credit/equity instruments
• Structured credit — ABS, RMBS, CMBS, CLOs

Personal answer framework: Choose an area you genuinely find interesting and can speak to with some depth. High yield and distressed is a strong answer for anyone drawn to active credit analysis — the mix of legal, financial, and strategic complexity in a restructuring is uniquely challenging. IG credit and credit derivatives is a strong answer for anyone more interested in macro-driven trading and client flow.

The two foundational ratio categories are coverage ratios (EBITDA ÷ interest expense) and leverage ratios (debt ÷ EBITDA). Both use EBITDA as the denominator or numerator because EBITDA represents the company's cash available for debt service before any financing, tax, or non-cash charges.

EBITDA matters in covenants specifically because:

Coverage ratio covenant: The debt document specifies a minimum EBITDA/interest expense ratio — for example, 2.5x. If EBITDA falls (due to a bad quarter or market downturn) or interest expense rises (due to rising rates on floating debt), the ratio can trip below this floor, triggering a technical default that requires a waiver or an equity cure from shareholders.

Leverage ratio covenant: The document specifies a maximum debt/EBITDA — for example, 5.0x. If the company takes on more debt (acquisition) or if EBITDA falls, the leverage ratio rises and can breach this ceiling. The company would then need to repay debt or inject equity to cure the breach.

Because EBITDA is so central to covenants, companies and their advisors spend significant effort on "EBITDA adjustments" — adding back one-time items, synergies from acquisitions, restructuring costs — to present the highest possible EBITDA number. This is a significant area of tension between borrowers and creditors: aggressive EBITDA adjustments can make a company appear more creditworthy than it truly is.

Credit spreads widen progressively as credit ratings decline, but not in a linear fashion — the relationship is convex, with spread widening accelerating sharply as you move into distressed territory.

Rough reference points (US dollar corporate bonds, approximate):

• AAA/AA: T+30 to T+80 — near-government risk, extremely tight
• A: T+60 to T+120 — still very tight, top-tier corporate credit
• BBB (lowest IG): T+100 to T+250 — the largest part of the IG market; BBB− bonds carry the most spread risk of any IG rating due to fallen angel risk
• BB (highest HY): T+200 to T+400 — crossing the IG/HY boundary brings a step-change in spread, reflecting forced selling and thinner liquidity
• B: T+350 to T+600 — meaningful default probability; leveraged buyout debt often sits here
• CCC: T+700 to T+1500+ — high probability of restructuring; the market prices significant loss scenarios
• Distressed/D (defaulted): Bonds trade at prices (not spreads) — typically 10–50 cents on the dollar based on expected recovery

The spread acceleration at the IG/HY boundary and again at the CCC/distressed boundary reflects the structural buyer changes at each level — forced seller dynamics and reduced liquidity compound the fundamental credit deterioration.

I follow credit through a combination of daily market monitoring and deeper research:

Daily: I track the ICE BofA IG and HY effective yield indices to monitor whether spreads are moving across the credit quality spectrum. I read the FT and Reuters credit coverage, which is strong on both European and US markets. Matt Levine's Money Stuff is essential — he writes about credit events, structured products, and corporate actions with a clarity and intelligence that most market commentary lacks.

Weekly/periodic: When I can access it, bank credit strategy research — Barclays Credit Strategy, Goldman credit commentary, and JPM credit research — provides the macro-to-credit linkages that daily news flow misses. These research pieces explain not just what spreads are doing, but why, and what the implications are for specific sectors and names.

Event-driven: I follow earnings season for major HY issuers and watch rating agency actions (upgrades, downgrades, outlooks) because they often precede significant spread moves. Major M&A announcements, leveraged buyout deals, and new HY issuance are all market events that tell you something about appetite for credit risk.

I should be honest that following individual corporate credits in depth — as a desk analyst would — is something you build on the job. My goal at this stage is to understand how credit markets move as a whole and follow the macro drivers that affect the whole space.

Private credit refers to direct lending by non-bank institutions — primarily large asset managers like Ares, Blue Owl, Apollo, and Blackstone — to companies that either cannot access public bond markets or prefer the flexibility of bilateral loan arrangements. It has grown explosively since the GFC as banks retreated from leveraged lending due to regulatory capital constraints.

The market now exceeds $2 trillion globally and is one of the fastest-growing segments in finance. Its growth was dramatically accelerated by the ZIRP era (2010–2021), when institutional investors desperate for yield poured capital into private credit funds offering 7–10% returns with supposedly low volatility.

Why it is a concern in 2026:

• Maturing ZIRP-era debt: Companies that borrowed in 2018–2021 at low rates are now refinancing in a higher-rate environment. Some cannot sustain the higher interest burden.
• Concentration risk: Roughly 40% of the private credit market is controlled by a small number of very large managers. Stress at one manager could have systemic effects.
• Opacity: Private credit loans are not mark-to-market daily. Problems can build without public visibility, unlike the transparent public bond market.
• Payment-in-kind (PIK) structures: Borrowers unable to pay cash interest are increasingly using PIK — adding interest to the principal rather than paying it — which delays recognition of distress but builds up the eventual debt burden.
• Contagion to public markets: Many private credit borrowers also have public bonds. Stress in private credit can transmit to HY spreads as markets price in sector-wide deterioration.