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Credit Derivatives Market Overview with Focus on Collateralized Debt Obligations - Essay Example

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This paper analyses the credit derivative products and their markets in terms of product characteristics and broad methodology in structuring such products. A preliminary measure of credit derivatives' market is made identifying the major participants and achieved market sizes. …
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Credit Derivatives Market Overview with Focus on Collateralized Debt Obligations

Download file to see previous pages... Therefore each type of entity would have different strategic motive for taking on positive or negative credit postures at any given point of time. Generally speaking Credit derivatives enable users to transfer credit risk, generate leverage or yield enhancement, proactively manage credit risk on a portfolio basis, manage regulatory capital ratios, decompose and separate risks embedded in securities (such as in convertible bond arbitrage), use as an alternative vehicle to equity derivatives (such as out-of-the-money equity put options), hedge and/or mitigate credit exposure and synthetically create loan or bond substitutes for entities that have not issued thus far for specific maturities.

Since much of the activity in credit derivatives is OTC and a good proportion of these negotiations are private and involve off balance transactions, size of the market turns tedious for exact measurement and only information that is available if of the nature of volunteered information from various market participants. An estimate of the global size of this primarily privately negotiated market was placed at $100 billion to $200 billion at the end of 1996. The British Bankers Association (BBA) estimated the size of the London market only to be about $20 billion at the end of 1996. These figures did not include the credit derivative transactions taken up by a good number of Japanese securities firms, which was mainly of the type to include credit default puts embedded in privately placed transactions. British Bankers Association (BBA) published a "Credit Derivatives Report" based on data collected from 25 major international players concerning their...
As the report declares credits risks are assumed by varied players in today's credit markets. These include. These include banks, government Agencies, corporates, securities companies, pension funds, insurance companies, fund managers, hedge funds etc. All of these entities have a calculated and strategic need to assume, reduce or manage credit risks and therefore the credit derivatives markets have typically players comprising of these entities. However the economic or regulatory motives of each of these entities differ because they have different market positions and are governed by varying regulations.
This paper stresses that credit derivatives are the products which involve the transfer, in part or entirety, of the credit risk of a credit obligation, without in any manner resulting in transference of the ownership of the reference credit product. As the conditionalities governing the basic credit products are evolving into sophisticated and fine tuned structures resulting in varying, splitting and multi-timing of credit risks so are the derived credit derivative products turning diverse and complex almost making for a robust and vibrant credit derivatives' market. Credit default swaps have turned really popular instruments in present day's credit derivatives' market. CDS are bilateral contracts agreeing to transfer the credit risk of one or more reference entities. The buyer of protection is therefore in a position similar to that of a short seller of a bond issued by the reference entity, and the market price of the CDS mirrors the degrees of risk inherent in the underlying credit asset. ...Download file to see next pagesRead More
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