Credit Derivatives : Main Concepts and Pricing

Abstract

The investors have the possibility to structure and to optimize the risk adjusted performance of their liabilities by diversifying them among several markets and instruments. Credit derivatives are financial instruments which allow a restructuring of the risk/return profiles of credits and permit investors to access new markets. They facilitate the trading of credit risk, its transfer and hedging. They can reduce transaction costs and provide managers a way to "short sell" loans or bonds. They offer to investors the possibility to leverage bond or loan positions. These products complete also the market since they provide a mean to synthesize assets which are not available in the market. This paper surveys the main types of credit derivatives and their valuation. Forward contracts on bonds, Total Return Swaps, Credit Default Swaps, Basket Default Swaps, Credit Default Exchange Swaps, Credit Linked Notes, Basket Default Notes, Levered Portfolio Notes, and Credit Spread Derivatives are subsequently studied in terms of definition, overview, structure, benefits, and pricing.