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Credit Derivatives

Overview of Credit Derivatives and Implementation in FinCAD and Bloomberg

March 15th 2006



Table of Contents

1. Introduction to Credit Derivatives ……………………………………………………………………………………3

2. Types of Credit Derivatives ……………………………………………………………………………………6

3. Using FinCAD to price Credit Derivatives …………………………………………………………………………………..10

4. Using Bloomberg to price Credit Derivatives
………………………………………………….………………………………22

5. References
………………………………………………………………………………… 27

Introduction to Credit Derivatives

What are Credit Derivatives?

Definition: A credit derivative is a derivative security that is primarily used to transfer, hedge or manage credit risk. Its payoff is materially affected by credit risk.

Credit derivatives are financial contracts that allow the transfer of credit risk from one market participant to another, potentially facilitating greater efficiency in the pricing and distribution of credit risk among financial market participants. Formally, credit derivatives are bilateral financial contracts that isolate specific aspects of credit risk from an underlying instrument and transfer that risk between two parties. In so doing, credit derivatives separate the ownership and management of credit risk from other qualitative and quantitative aspects of ownership of financial assets.

The need and advantages of credit derivatives

1. Until recently, credit remained one of the major components of business risk for which no tailored risk-management products existed
2. Without credit derivatives, credit risk management was inefficient primarily because they do not separate the management of credit risk from the asset with which that risk is associated. For example, these strategies would either mean purchasing insurance on the credit risk exposure or simply carry the open exposure on the portfolio.
3. The Reference Entity, whose credit risk is being transferred, need neither be party to nor aware of a...