What Are Credit Derivatives?

Credit derivatives are financial derivatives that use the credit of a loan or bond as the underlying asset, which is essentially a bilateral financial contract arrangement.

Credit derivatives

Right!

Credit derivatives are loans or

Under this contract, the payment of the agreed amount by both parties to the transaction depends on the credit status of the loan or bond payment.There are usually two ways to trade it, namely

credit

1. Disperse credit risk

The emergence of credit derivative products has provided credit risk management with its own technology. Through credit derivative products, credit risk can be stripped and transferred from other risks, thereby better solving the bank's credit paradox in risk management practice. . With the help of credit derivatives, banks can not only avoid excessive concentration of credit risks, but also continue to maintain business relationships with customers, which is undoubtedly revolutionary to the traditional banking business philosophy. Through the pricing and trading of credit risk, more investors can participate in the credit risk market, which enables credit risk bearers in the financial market to expand from banks to various types of institutions such as insurance, funds, and enterprises. The overall risk resistance of financial markets.

2.Improve return on capital

The risk-return characteristics of financial assets can be expressed by two parameters of expected return and unexpected loss. Among them, the expected return depends on the spread and credit loss, and the calculation of unexpected loss is based on the assumption that many credits default at the same time. The ratio of expected earnings to unexpected losses is an indicator similar to the Sharpe ratio. By reducing assets with high unexpected losses and low expected returns, or increasing assets with positive contributions to increase the ratio of expected returns to unexpected losses, the purpose of improving the expected performance of the asset portfolio can be achieved. Without credit derivatives, market participants can only achieve these goals by buying or selling financial assets. But using credit derivatives, it is easy to implement these strategies and improve the return on financial capital.

3.Improve the liquidity of the basic market

Credit derivative products separate the credit risk of financial assets, and through credit stratification, credit enhancement, bankruptcy isolation and other financial engineering, especially credit engineering technology, change the risk-return characteristics of financial assets and transform them into tradable Financial products, thereby greatly enhancing the liquidity of financial markets.

In addition, credit derivatives are a re-integration of financial markets, allowing financial institutions to enter more market areas, which is equivalent to connecting all markets, which helps increase market liquidity.

4. Improve the efficiency of financial markets

In financial transactions with credit derivatives, due to the emergence of third-party buyers of credit risk, it greatly reduces the adverse selection and moral hazard problems caused by information asymmetry in the financial market, thereby reducing financial transaction costs and effectively Promote operational efficiency in financial markets. On the other hand, the continuous trading of credit derivatives will also make some hidden information in the financial market more open and enhance market transparency, so that the price of financial assets can reflect more market information, and the pricing of financial assets will also be more effective.