Swap market provided derivative organizations with profit due to their intermediary position while the credit margins for borrowers were reduced. As the swap market developed there was the development of new interest derivatives so that there were additions to the list of products. Credit derivatives are relatively recent introductions and these are mechanisms for the credit institutions to separate the credit risk from their loans and treat market risk as a separate category so that their pricing efficiency could be more competitive and the concerned organizations could be more competitive in the market. (Credit Derivatives Move Beyond Plain Vanilla)
Thus one can say that credit derivatives are a recent form that can be used by bankers to reduce risk, or increase risks and thus meet their corporate objectives. The general form of credit derivatives is a bilateral contract and the aim of that contract is to reduce their exposure to credit risk. For a bank like ours, the feeling may be that one particular customer is in difficulty and may not be in a position to repay the loan that has been given to him, or has been renewed for him. The bank can seek protection through selling the concerned credit risk to another party, though the risk will still remain on its books. It is not only for loans that the procedure may be used, but for any debt instrument or a group of instruments. While going through the procedure, one of the side results is the establishment of a default price for the loan or instrument. Apart from the reduction of risk, other organizations which have not made the loan can gain benefits from the loan that they have not made directly. (Credit Derivatives Move Beyond Plain Vanilla)
In a way the instrument offers a flexible method of managing risks of credit and also to improve yields from credits synthetically. This is due to the ability that it gives methods to purchase synthetic credit. At the same time, it cannot remove all risks in giving credits as though it may not have given direct credit to a company which is in a little difficult position, it may have got into a derivative for that company. There are also other instruments like Special Purpose Corporations/Vehicles that can be created to avoid the risks of getting into derivatives of companies with a little risky situation. This leads to different forms of credit derivatives - Credit Linked Notes, Total return Swaps, Credit Default Puts, Credit Spread Options and other forms. The concerned definition of credit risk in all these discussions is the likelihood of the borrower failing to service or repay a debt in time. The market notes this deficiency through the user of the credit rating for the party, and this is what defines the premium that it pays over the market price for its debts.
Thus the risk involved in giving a loan to a party has two elements - market risk and firm-specific risk. The benefit of credit derivatives is that it is allowing the lender to separate the risks that are involved and then insuring itself by selling those risks to others who are in the best position to evaluate and manage those risks. Earlier the methods of controlling them were through refusals to make loans, taking out insurances, through guarantees and letters of credit, etc. These were useful in normal situations, but when the market itself moved into a difficult situation due to economic downturns, and then all parties were likely to default at the same time. Thus financial institutions felt that they needed more security and came out with this scheme. (Credit Derivatives Move Beyond Plain Vanilla)
Now the credit derivatives market has grown and is expected to be near the $1 trillion mark, and this is causing demands for the systems to be calculated easily. This is leading to requirement of technology and other support for the trade and management of credit instruments. Leading organizations dealing in this area have already asked their software suppliers to develop applications which will support their business. (Designed for dealing) Earlier the use of these instruments were limited to banks, but now among the users are a large number of insurance companies, hedge funds, mutual funds, pension funds, corporate treasuries and even direct investors who are trying to get their yields increased or transfer...
The article that was written by Conley (2011) discusses the impact that collateralized debt obligations (CDO's) would have upon the subprime loans. These were created in 1987, by the Wall Street firm Drexel Burnham. In this product, the investment bankers would take a number of different articles and combine them together as one investment. The various assets that were used included: junk bonds, mortgages and other high yielding investments from
Derivatives -- Perceptions of Value and Use Realistic & Empirical Research Approaches in Finance Empirical research (which originates from the positivist tradition) and qualitative research are sufficiently distinct in their philosophical grounding to ask very different types of research questions. Empirical research is a theory-building endeavor that seeks to add to theory by determining the degree to which the hypotheses in a study are true or false. Qualitative research does not begin
Thus, the company is not attempting to either "win" or "lose" with its transactions. Thus, either may occur over any given period. An example of a fuel hedging "loss" occurred in late 2008 and into 2009. During this period of high volatility, fuel prices shot up as high as $140 per barrel in mid-2008, only to quickly crash down to $40. This volatility is a tremendously challenging environment. The
Derivative Securities Derivatives (Black Tuesday) Derivative Securities Derivative Securities It is difficult to understand or explain why throughout history some negative investor philosophies continually repeat themselves. Far too often investors miss blatant signs that lead to major collapses in the free markets. The purpose of this report is to discuss derivative securities in detail and how they affect those investor philosophies. Even unsophisticated investors understand that the stock and commodities markets are supposed to fluctuate
International Financial Markets and Institutions: Throughout the globe, today's landscape of international financial market and institutions has continued to experience several changes that require practitioners to examine new models. The need for practitioners to examine new models that are relevant to the state of these markets and institutions has also been necessitated by the recent events that contribute to financial crises, which have been very dramatic. Actually, the recent financial crisis
" Bhattacharya (1988). It is used to calculate the value of a company based on its total cash flow. (Ross, 1988). Bhattacharya (1998) states that this theory assumed that lower dividends will lead to reduced levels of new equity and this will bring about a balance between the debt and equity of a company. This is not ture for utilities companies and other monopolistic firms where new equities are rare. For the
Our semester plans gives you unlimited, unrestricted access to our entire library of resources —writing tools, guides, example essays, tutorials, class notes, and more.
Get Started Now