Morgan Stanley 2015 Annual Report Download - page 181

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Single Name Credit Default Swaps.
A credit default swap protects the buyer against the loss of principal on a bond or loan in case of a default by the issuer. The
protection buyer pays a periodic premium (generally quarterly) over the life of the contract and is protected for the period.
The Company in turn will have to perform under a credit default swap if a credit event as defined under the contract occurs.
Typical credit events include bankruptcy, dissolution or insolvency of the referenced entity, failure to pay and restructuring
of the obligations of the referenced entity.
Index and Basket Credit Default Swaps.
Index and basket credit default swaps are products where credit protection is provided on a portfolio of single name credit
default swaps. Generally, in the event of a default on one of the underlying names, the Company will have to pay a pro rata
portion of the total notional amount of the credit default swap.
The Company also enters into tranched index and basket credit default swaps where credit protection is provided on a
particular portion of the portfolio loss distribution. The most junior tranches cover initial defaults, and once losses exceed the
notional of the tranche, they are passed on to the next most senior tranche in the capital structure.
Credit Protection Sold through CLNs and CDOs.
The Company has invested in credit-linked notes (“CLNs”) and CDOs, which are hybrid instruments containing embedded
derivatives, in which credit protection has been sold to the issuer of the note. If there is a credit event of a reference entity
underlying the instrument, the principal balance of the note may not be repaid in full to the Company.
Purchased Credit Protection with Identical Underlying Reference Obligations.
For single name credit default swaps and non-tranched index and basket credit default swaps, the Company has purchased
protection with a notional amount of approximately $577.7 billion and $731.0 billion at December 31, 2015 and
December 31, 2014, respectively, compared with a notional amount of approximately $619.5 billion and $804.7 billion at
December 31, 2015 and December 31, 2014, respectively, of credit protection sold with identical underlying reference
obligations.
The purchase of credit protection does not represent the sole manner in which the Company risk manages its exposure to
credit derivatives. The Company manages its exposure to these derivative contracts through a variety of risk mitigation
strategies, which include managing the credit and correlation risk across single name, non-tranched indices and baskets,
tranched indices and baskets, and cash positions. Aggregate market risk limits have been established for credit derivatives,
and market risk measures are routinely monitored against these limits. The Company may also recover amounts on the
underlying reference obligation delivered to the Company under credit default swaps where credit protection was sold.
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