Markit publishes investable basket CDS indices. These are indices intended to track the credit risk of a basket of issuers (e.g. in the case of iTraxx Europe Series 24 these are 125 names) in an investable way. The weight of each name in the index in this case is 0.8%.

How can I construct a bond portfolio that has a similar credit exposure. How do I choose the weights? Is it correct to invest the same notional into bonds of each issuer? Then notional*traded price gives me weights for each bond that differ from 0.8%.

Say as a toy example I have an index with 2 issuers. Then they are weighted 50%/50% in the index. For issuer 1 I have a bond A with a matching maturity that trades at 90. For issuer 2 I have a bond B that trades at 110.

What is the equivalent of investing 1 Mio EUR in the basket? In the basket case I have an exposure of 500K EUR to issuer 1 and the same for issuer 2.

In the portfolio case I can invest a notional of 500K in bond A which costs 450K and a notional of 500K in bond B at a price of 550K which gives a weighting of 45% to 55% in the portfolio.

On the other hand if I invest a notional of approx 555 555 into A (at a price of 90) and 454545 in B (at a price 110) then I get a 50%/50% weighting.

Which one corresponds better to what a basket CDS represents?


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