CREDIT DERIVATIVES
Credit Derivatives is summation of two terms,
Credit + Derivatives.
As we know that derivative implies value deriving from an underlying, and this underlying can be anything we discussed earlier i.e. stock, share, currency, interest etc.
Initially started in 1996 due to the need of the banking institutions to hedge their exposure of lending portfolios today is one of the structured finance product.
Plainly speaking the financial products are subject to following two types of risks:
(a) Market Risk: Due to adverse movement of the stock market, interest rates and foreign exchange rates.
(b) Credit Risk: Also called counter party or default risk, this risk involves non-fulfilment of obligation by the counter party.
While, financial derivatives can be used to hedge the market risk, credit derivatives emerged out to mitigate the credit risk. Accordingly, the credit derivative is a mechanism whereby the risk is transferred from the risk averse investor to those who wish to assume the risk.
Although there are number of credit derivative products but in this chapter, we shall discuss two types of credit Derivatives ‘Collaterised Debt Obligation’ and ‘Credit Default Swap’.
Initially started in 1996 due to the need of the banking institutions to hedge their exposure of lending portfolios today is one of the structured finance product.
Plainly speaking the financial products are subject to following two types of risks:
(a) Market Risk: Due to adverse movement of the stock market, interest rates and foreign exchange rates.
(b) Credit Risk: Also called counter party or default risk, this risk involves non-fulfilment of obligation by the counter party.
While, financial derivatives can be used to hedge the market risk, credit derivatives emerged out to mitigate the credit risk. Accordingly, the credit derivative is a mechanism whereby the risk is transferred from the risk averse investor to those who wish to assume the risk.
Although there are number of credit derivative products but in this chapter, we shall discuss two types of credit Derivatives ‘Collaterised Debt Obligation’ and ‘Credit Default Swap’.
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