The credit derivatives market is rapidly developing. Taking credit derivatives of alltypes, about $5,000 billion in debt will be protected against default during 2004.Whilst the range of available instruments and their application continues to increase,the market still lacks, at the present writing, the transparency and liquidity of moretraditional, exchange-traded instruments. However, a number of institutional attemptsto standardise the market, for example by the International Swaps and DerivativesAssociation (ISDA) and the emergence of active credit derivative indices such asiBoxx, conceived by a consortium of banks, and Trac-X, launched by Morgan Stanleyand JP Morgan (now managed by Dow Jones), are beginning to fashion the creditderivatives market into a more generally useful form. No attempt is made here toconsider all of the available instruments and applications of credit derivatives for thecorporate user. Rather, we illustrate the potential usefulness of these instruments byfocusing in on two particular kinds of instrument: the Credit Default Swap and theTotal Return Swap.The remainder of the paper is structured as follows.
introduces the creditderivatives markets, and considers briefly the main contracts available in the over-the-counter market.
looks at the impact of the credit derivatives market on non-financial corporations. In
, we consider the use of credit derivatives bycorporate risk managers to manage their external credit risk exposure. This isfollowed up, in
, with a consideration of whether managers should trade incredit derivatives written against their
companies. They may, for example, wishto purchase credit protection to hedge against receipts from future bond issues, or sellcredit protection to exploit informational asymmetry.