Credit Derivatives

Worldly wisdom teaches that it is better for reputation to fail conventionally that to succeed unconventionally”

Life is either a daring adventure or nothing. Security does not exist in nature, nor do the children of men as a whole experience it. Avoiding danger is no safer in the long run than exposure.

I can calculate the motions of the heavenly bodies, but not the madness of the people. after Isac Newton lost money in the market.

“Betting against the bubble is dangerous, but its one of the rewarding thing, it’s truly a pleasure”. In your mind you’re going to be right ultimately; there’s a cetain virtue in being done.

Well the above remarks made by some great persons while trying to understand the market of derivatives. People write to remember things, I write to forget. I am sure that definitely had many post on Credit derivatives. Many of my friends and colleagues are still not so familiar with them and just wanted to define for them . For them the understanding of credit derivatives is that these monster was behind the subprime crisis in 2008, Lehman crisis, and later the Eurocrisis and now the Grexit.

Let me try to put some definitions quote and unquote:

” Credit derivatives is a general term used to describe various swap and option contracts designed to transfer credit risk on loans or other assets from one party, the protection buyer, to another party, the protection seller. The protection seller receives premium or interest-related payments in return for contracting to make payments to the protection buyer,which are linked to the credit standing of a reference asset or assets. ” FSA UK

Or putting it simple :

Credit derivatives can be defined as arrangements that allow one party (protection buyer or originator) to transfer, for a premium, the defined credit risk, or all the credit risk,computed with reference to a notional value, of a reference asset or assets, which it may or may not own, to one or more other parties (the protection sellers).

Simplifying few jargons :
Protection buyer : The party that wants to transfer the credit risks.
Protection seller : The party that provides protection against the risks.

Just to name few types of credit derivatives
1) CDS Credit default Swaps
2) CLN Credit link notes
3) Credit Spread options

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