Disadvantages Of Credit Derivatives
What it means:
A credit derivative is a financial instrument which results in a trade between two parties. One of them is the protection buyer which makes periodic payments to another party, the protection seller. In this trade the protection seller indemnifies the protection buyer against any losses he experiences as a consequence of the default of some credit-risky reference asset. Credit derivative is one of the various instruments and techniques which are designed to separate and then transfer the credit risk. They effectively distribute the credit risk across the market and as a result help the institutions to deal with the risk management objectives and maintain customer relationships.
Why is it important:
The advent of credit derivatives has led to an effective and increasingly liquid market for transferring the credit risk attaching loan asset separately from its ownership. The main benefit of Credit derivatives is that it has numerous applications and this would have far reaching consequences for the way banks manage credit risk in the future. For instance, there is already an increased focus towards active credit portfolio management, enabling banks to improve returns on both economic as well as regulatory capital through the trading of credit derivatives. Banks are thus able to pass the default risk associated with their assets on to third parties while simultaneously retaining legal title to the assets. Credit derivatives, except when embedded in structured notes, are off-balance sheet instruments. They offer considerable
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• Another important feature of credit derivatives trades is that the borrowers are not typically informed that their loan is the reference asset for a
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