Abstract
Almost all of the
financial instrument are inherent with credit risk, which is exposed if the
borrower is unable to meet the financial obligation on time. To minimize such
credit risk financial institution go thoroughly to the credit worthiness of the
borrower, which is a traditional way to minimize the potential risk by avoiding
it. The modern evolution of financial market have developed sophisticated
instrument and techniques to minimize credit risk. One of them is credit
derivative, these instrument helps to segregate the credit risk from the
underlying assets and makes the credit risk tradeable. The first part of the
article is focused on the introduction, development and advantage of credit
derivative. The second part analyze the various types of credit derivative
instrument as modern technique for managing potential credit risk. Finally some
of the risk associated with the credit derivative instrument have been analyzed
on the third part to give the basic outlook on the various instrument of
sophisticated credit risk management instrument of advance Derivative and
Commodities market.
Keyword: Credit
Risk, Credit Derivative, Credit Default Swap, Total Return Swap, Assets Swap,
Credit Linked Note
Introduction
Credit
Derivative indicates the instrument or technique that helps to separate and
transfer one of the major risk of traditional finance; that is credit risk.
Credit risk is associated with the obligation, it arises when the
pre-determined obligation with financial instrument is not fulfilled on time.
This indicates the counter party default on promised obligation. Derivative
products or Instrument created on this credit risk is credit derivative
product, they were first purposed in 1992 at Conference of International Swap
and Derivative Association (ISAD). A credit derivative consist privately held
negotiable contract that allows users to manage their exposure to credit risk
related to an underlying entity from one party to another without the actual
transference of underlying entity. Credit derivative also enables stripping the
credit risk of a security from its other risk. Credit derivative are the over
the counter (OTC) product and hence can be tailored to the user specification.
