Credit Derivatives:Credit derivatives are typically bilateral contracts that enable one party to either assume or reduce credit

exposure on one or more debt obligations of named issuers. It helps in transferring a specified risk from one party to another, based on their ability to bear the risk. Different CD products are listed below:1) 2) 3) 4) 5) 6)

Single Name credit default swaps Basket and Portfolio Credit Default Swap Credit-Linked Note Total Return Swaps Synthetic Collateralized Debt Obligations Credit Default Swap Indices

Definitions:Reference Entity (Issuer): - Issuer of the debt instrument Reference Asset (Obligation): Particular debt issue for which credit protection being sought. Credit Event: - An incident which triggers the payout process. Bankruptcy, merger, downgrade, failure to pay are some of the common credit events.

Single Name credit default swaps

A CDS was a bilateral contract between two parties, in which one party (the protection seller) would be obligated to compensate the other party (the protection buyer) for any decline in the market value of a reference asset (bond or other debt instrument) issued by reference entity due to the occurrence of credit event. Protection buyer will pay an annual premium to the protection seller in quarterly instalments. These payments would be made over the life of the contract, or until the reference entity defaulted, in which case the CDS would be settled. If credit event occurred, protection buyer can be compensated for loss through physical settlement or cash settlement. In physical settlement, the protection buyer would physically deliver to the protection seller a total face amount of debt in the reference entity equal to the notional amount of the CDS, in exchange for a cash payment from the protection seller equal to this notional amount. In cash settlement, in which the protection seller would make a cash

payment to the protection buyer equal to the difference between the notional amount and the market value of the debt.

Basket and Portfolio Credit Default Swaps:

These are CDs, which allows one to buy or sell protection against credit losses on a basket or portfolio of debt instruments issued by multiple reference entities. The contract provided protection against a specified fraction of total default-related losses incurred on a portfolio of debt issued by multiple reference entities.

Credit-Linked Note:
In credit-linked notes buyer has a collateral at the time the transaction is initiated. The protection buyer sells CLNs by promising a coupon rate and a stated maturity.

Total Return Swaps:

A total return swap (TRS) is an agreement between two parties that exchanges the total return from a financial asset between them. This is designed to transfer the credit risk from one party to the other. It is one of the principal instruments used by banks and other financial instruments to manage their credit risk exposure. In a TRS, an investor could contract with a counterparty to receive the cash payments generated by a risky corporate bond, without having to purchase the bond itself. The TRS obligated the counterparty to make payments to the investor during the term of the contract that exactly replicated all payments on the bond. If the bond did not default, then when the TRS matured the counterparty would make a final payment to the investor equal to the capital gain, if any, that the bond had realized since the TRS was created. If the bond defaulted prior to the maturity date of the TRS, the TRS would be terminated, and, as in the no-default case, a final payment would be made between investor and counterparty reflecting any capital gain or loss on the bond.

Synthetic Collateralized Debt Obligations

A synthetic CDO raises money from investors through the sale of notes (divided into riskbased tranches). However, rather than invest directly in risky debt (like traditional CDO), a synthetic CDO achieved the same credit exposure through the use of credit derivatives. The synthetic CDO would invest the proceeds from the note sales in investment-grade securities and simultaneously sell a portfolio credit default swap on a reference basket of risky corporate bonds to the sponsoring bank.

Credit Default Swap Indices

Credit default swap indexes (CDXs) are portfolios of single-name default swaps. They serve two important functions. First, they make it possible for investors to actually trade portfolios of single-name CDS contracts. This is perhaps the most useful function of a CDX. Portfolio managers of corporate bonds and loans can alter their exposures by either buying or selling these indexes.