Monday, June 18, 2018

Credit Derivative: An Introduction

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
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.