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Use Cases: Debt focused Exchange with Automated Credit Rating Mechanic
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Hexxx
Sebiestor Tribe
Minmatar Republic
#1 - 2014-05-15 15:54:28 UTC  |  Edited by: Hexxx
If you haven't read it already, please see the initial design document here: Proposal: Debt focused Exchange with Automated Credit Rating Mechanic

What follows are Use Cases for the design. Feedback and comments are welcome.

User Role Definitions

• User 1 – Corporation/Alliance/Bond Originator
• User 2 – Bond Buyer
• User 3 – Bond Seller
• User 4 – Credit Default Swap (CDS) Contract Writer
• User 5 – CDS Buyer
• User 6 – CDS Seller
• User 7 – General User/Shared Use Cases

Use Cases

User 1 Use Cases (Corporation/Alliance/Bond Seller)

• User 1 must validate their identity as CEO of a Corporation or as CEO of the founding Corporation of an Alliance
• User 1 creates a Bond, defining the amount of principal for sale, monthly interest payment, and maturity date. Bonds are sold in shares of 1 Million ISK.
• User 1 has the ability to return the principal in advance of the maturity data, with interest paid out on a pro-rated basis for that month.
• User 1, when creating a bond, can define a maturity date between 1 and 12 months.
• User 1, if they would like to re-finance, can simply create a new bond sale to pay off an existing bond at maturity date.
• User 1, after the sale period of 5 days, will be sent the amount of funds raised. This may or may not be what they attempted to raise. Another Bond series could be created if the initial offering failed to raise the capital desired.

User 2 Use Cases (Bond Buyer)

• User 2 can create a buy order for the Bond – this buy order (contract) must be covered by funds already in their account. They can specify how many days (1-14) they would like their order good for and the number of shares in that order.
• When User 2 creates a Bond buy order, the money required for the order is placed in Escrow – still visible to User 2 in their account but not available unless the order is canceled.
• A Bond buy order is executed when it is equal to or above a sell order. Price paid per share is determined by the sell order price. If a buy order is for 100 Isk per share and a sell order is for 80 Isk per share, the buy order will be executed at a price of 80 Isk per share.
• When User 2 has their Bond buy order executed, shares are placed in their Portfolio and funds in Escrow associated with that order are removed from User 2 and allocated to User 1.

User 3 User Cases (Bond Seller)

• User 3 can view their Portfolio for Bonds they own. They have the option to select “Sell” for any Bond in their portfolio. This will take them to the Sell Order Creation, which includes Bond Detail that show a trend of volume traded for that Bond, current buy and sell orders for that Bond, last price/date on an executed order, and the CDS Market for that Bond.
• User 3, when creating their sell order, must specify how many days (1-14) they would like their order good for and the number of shares in that order. They can then preview that order and have the option to confirm the order or modify the order. Confirming the order creates the order and modifying the order returns them to creating the sell order again.

User 4 User Cases (Credit Default Swap (CDS) Contract Writer)
• User 4 can create a CDS contract for sale and determine the price of the contract. Automated updates to calculations will display information about the credit spread, nominal value of the contract, and other relevant information. They can then preview that contract and have the option to confirm the contract sell order or modify the order. Confirming the order creates the contract sell order and modifying the order returns them to creating the contract again.
• Contract terms are derived from the underlying bond. Duration and payout are fixed.

User 5 User Cases (CDS Buyer)
• User 5, upon viewing the CDS Market for an individual Bond, can then create a buy order for the CDS contracts derived from the underlying Bond. Doing so requests information on how many contracts the buy order is for and what the order price is for. Once these are put in, automated information on the nominal value of the contract and its spread are displayed. The user is then presented with the option to confirm the contract buy order or modify the order. Confirming the order creates the contract buy order and modifying the order returns them to creating the contract again.

User 6 User Cases (CDS Seller)
• User 6, upon viewing the CDS Market for an individual Bond, can then create a sell order for the CDS contracts derived from the underlying Bond. Doing so requests information on how many contracts the sell order is for and what the order price is for. Once these are put in, automated information on the nominal value of the contract and its spread are displayed. The user is then presented with the option to confirm the contract sell order or modify the order. Confirming the order creates the contract sell order and modifying the order returns them to creating the contract again.
• When a CDS is sold, the payout amount of the contracts is placed in escrow. You must have enough to cover the payout.

User 7 User Cases (General User/Shared Use Cases)
• User 7 views the Bond Market. They can filter/sort by when the bond was created (date), the interest rate being offered (%), duration of the bond (measured in days), and number of shares currently for sale on the market (number).
• User 7 can view each Bond in further detail. The Bond Detail will show a trend of volume traded for that Bond, current buy and sell orders for that Bond, last price/date on an executed order, and the CDS Market for that Bond.
• User 7 views the CDS Market for an individual bond. They can filter/sort by when the CDS was created, interest rate, etc.
Hexxx
Sebiestor Tribe
Minmatar Republic
#2 - 2014-05-16 13:15:53 UTC  |  Edited by: Hexxx
Scenario #1

An investor buys a share of a Bond that will run for 6 months at 4.5% interest a month. The share price is 100,000,000 ISK. To simplify this, the Bond payment schedule would be:

End of Month 1: 4,500,000 ISK
End of Month 2: 4,500,000 ISK
End of Month 3: 4,500,000 ISK
End of Month 4: 4,500,000 ISK
End of Month 5: 4,500,000 ISK
End of Month 6: 4,500,000 ISK + 100,000,000 ISK

The investor stands to profit 27,000,000 ISK on their 100,000,000 ISK investment, or a total return of 27% over 6 months.

The Bond is with the PewPewPew Alliance that has been around for a number of years and is viewed as reliable, though recent conflict the BoomBoomBoom Alliance places it in harm’s way – potentially straining its ability to repay its debt. The investor decides to manage the risk of their Bond investment and purchase a Credit Default Swap (CDS) contract when they buy their share of the Bond.

The investor purchases a CDS contract with a payout of 100,000,000 ISK for 10,000,000 ISK on the underlying Bond. This represents a spread of 90% between the price of the contract and its payout. This spread serves as a proxy for the risk assessment of the Bond by the buyer and the seller on the risk of default.

3 months pass and the PewPewPew Alliance who issued the Bond has a traitorous spy disband the BoomBoomBoom Alliance wins a major military victory against the BoomBoomBoom Alliance, removing it as a threat. The underlying CDS contract market price drops 90% to 1,000,000 ISK.

The investor no longer wishes to hedge their risk and sells their contract on the market for 1,000,000 ISK. The spread between price and payout is now 99% as the market views the underlying Bond as much less risky.

Another 3 months pass and the Bond pays out its final interest payment plus principle. The investor recognizes a total gain of 18,000,000 ISK or 18% after accounting for the CDS contract expense of 9,000,000 ISK.

Meanwhile, the original contract writer/seller (a member of the PewPewPew Alliance who was confident the risk of default was near 0%) made 9,000,000 ISK, or 9%, on 100,000,000 ISK held in escrow. Once the contract was bought back, it was closed and the original contract seller recognized the return of 100,000,000 from an escrow account.

The Bond investor made 18% over 6 months.
The Contract writer/seller made 9% over 3 months.
Nedly Stark
ARAZ Engineering
#3 - 2014-05-16 14:46:57 UTC
Interesting, this should be fun to watch. Good luck.
Magnu Stormhawk
#4 - 2014-05-16 16:37:41 UTC
Hexxx wrote:

User 5 User Cases (CDS Buyer)
• User 5, upon viewing the CDS Market for an individual Bond, can then create a buy order for the CDS contracts derived from the underlying Bond. Doing so requests information on how many contracts the buy order is for and what the order price is for. Once these are put in, automated information on the nominal value of the contract and its spread are displayed. The user is then presented with the option to confirm the contract sell order or modify the order. Confirming the order creates the contract sell order and modifying the order returns them to creating the contract again.


Did you mean buy order instead of sell order here (twice)?
Hexxx
Sebiestor Tribe
Minmatar Republic
#5 - 2014-05-16 17:26:25 UTC
Magnu Stormhawk wrote:
Hexxx wrote:

User 5 User Cases (CDS Buyer)
• User 5, upon viewing the CDS Market for an individual Bond, can then create a buy order for the CDS contracts derived from the underlying Bond. Doing so requests information on how many contracts the buy order is for and what the order price is for. Once these are put in, automated information on the nominal value of the contract and its spread are displayed. The user is then presented with the option to confirm the contract sell order or modify the order. Confirming the order creates the contract sell order and modifying the order returns them to creating the contract again.


Did you mean buy order instead of sell order here (twice)?


Yes. Sad
Hexxx
Sebiestor Tribe
Minmatar Republic
#6 - 2014-06-04 15:00:51 UTC
Updated thread with example Scenario, see the second post in the thread.
Kell Ark
Venture Inc
#7 - 2014-06-04 18:36:41 UTC
Quote:
• User 4 can create a CDS contract for sale and determine the price of the contract. Automated updates to calculations will display information about the credit spread, nominal value of the contract, and other relevant information. They can then preview that contract and have the option to confirm the contract sell order or modify the order. Confirming the order creates the contract sell order and modifying the order returns them to creating the contract again.



I might have missed it somewhere, but how do you enforce CDS seller to actually cover bond default? He`ll have to put nominal bond sum to escrow?
Hexxx
Sebiestor Tribe
Minmatar Republic
#8 - 2014-06-06 13:28:43 UTC
Kell Ark wrote:
Quote:
• User 4 can create a CDS contract for sale and determine the price of the contract. Automated updates to calculations will display information about the credit spread, nominal value of the contract, and other relevant information. They can then preview that contract and have the option to confirm the contract sell order or modify the order. Confirming the order creates the contract sell order and modifying the order returns them to creating the contract again.



I might have missed it somewhere, but how do you enforce CDS seller to actually cover bond default? He`ll have to put nominal bond sum to escrow?


The contract seller/writer must have the value of the payout in their accounts when creating a contract to sell. The amount is placed in escrow when the contract is completed.

That said, I made the contract payout and the bond share price the same in this example for the sake of simplicity - I intend to have contracts be less in payout, perhaps 10%, of the nominal value of each bond share. That way a person can choose how MUCH of the debt they'd like to hedge.

Also, remember, the contracts are a synthetic instrument, you don't need to hold the bond to buy them or sell them. Pirate
Quant Predictorian
Center for Advanced Studies
Gallente Federation
#9 - 2014-06-19 17:23:38 UTC
Very interesting idea. It would help startups to reach angel investors and VCs better way and it also removes the word "trust" in loan contracts. Same scenario can be done by creating derivatives market in which corp options created. Option sellers (writers) would offer insurance to shareholder of a corp.

Both ideas can be done off-site.

Investor, ancap, correspondence chess player, Fischer random fan (http://www.chess959.com)
Hexxx
Sebiestor Tribe
Minmatar Republic
#10 - 2014-06-19 17:56:57 UTC
Quant Predictorian wrote:
Very interesting idea. It would help startups to reach angel investors and VCs better way and it also removes the word "trust" in loan contracts. Same scenario can be done by creating a derivatives market in which corp options created. Option sellers (writers) would offer insurance to shareholder of a corp.

Both ideas can be done off-site.


I'm currently preparing a few use cases for an "Underwriter" as well. The more I dealt with the technical requirements the more obvious the value of one is in terms of financing the bond then turning and selling some portion (or all) of the bond to the market.

I've simplified the contract use cases as seen in the examples, removing a periodic premium in exchange for reliance on the contract market price.

I'm currently creating data models for the objects I'll need as I work on the technical requirements documentation.
Zenshift
Offworld Accounts
#11 - 2014-06-19 23:50:57 UTC
This is a cool idea, although I can't say I fully understand it. My question is will it rely on in game events/wars/organization collapses that scenario 1 represents or can it exist in a static market over a long period of time and not only be mutually beneficial but also isn't redundant.
Hexxx
Sebiestor Tribe
Minmatar Republic
#12 - 2014-06-20 15:08:55 UTC
Zenshift wrote:
This is a cool idea, although I can't say I fully understand it. My question is will it rely on in game events/wars/organization collapses that scenario 1 represents or can it exist in a static market over a long period of time and not only be mutually beneficial but also isn't redundant.



It will exist outside of in-game, tied explicitly to character identity for participants. Events that effect this market will be events that occur in the market itself.

For example, an event of technical default will be a missed interest payment. This occurs only on the web application.
Zenshift
Offworld Accounts
#13 - 2014-06-20 23:35:36 UTC
That makes sense. Thanks for clarifying.