Abstract
Due to the global depression economy with the low interest rate accompanied, the credit derivatives and interest rate derivatives have been blossoming. Structure notes are tailor-made products which are created by nancial engineering. In Lotz and Schlogl (2000), they supposed a model for nite-interval interest rates, for example, LIBOR (London InterBank O ered Rate) rate, which explicitly takes into account the possibility of default through the in uence of a point process with deterministic intensity. They relate the defaultable interest rate to the non-defaultable interest rate and to the credit risk characteristics default intensity and recovery rate in comparison with the forward LIBOR model that can derive the appropriate model assumption by using the observable market rate to calibrate the parameter of the model. Before having modi ed market model process, we should construct the termstructure of default intensity in advance that can transform non-defaultable into defaultable interest rate. Therefore, the rst aim of this study is to utilize the modi ed market model to construct the defaultable LIBOR rate, and to use defaultable cap to calibrate the instantaneous volatility of defaultable LIBOR used in modi ed market model as a parameter. After simulating defaultable LIBOR rate has been developed, the cash ows of credit linked notes will be identi ed. The second aim of this study is following Sch�onbucher (2000), he models effective default-free forward rates and forward credit spreads as lognormal di usion processes. Therefore, we also consider that default intensity is stochastic, and analyze what e ects will be produced in di erent correlation coefficient Keyword : Credit linked notes, LIBOR market model, default intensity