A negotiable contract between two parties (bilateral always) that allows them to manage their credit risk by using a derivative instrument to transfer the risk from one to another. In this kind of contracts, a “risk transfer” fee is paid by the party willing to mitigate the risk to the party accepting to bear it. And so, the price of credit derivatives, like that of similar derivatives (options and swaps), is driven by the credit risk one party is exposed to. For example, a lending bank can protect itself against potential customer default by transferring the default risk to another party (investor, government, financial institution, etc). Though the loan is still on the bank’s books, the risk, thanks to this derivative, is mitigated, being borne now by a third party.
Derivatives
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