Page 161 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes  In recent years, stiff competition among lenders, a tendency by some banks to treat lending
as a loss-leading cost of relationship development, and a benign credit cycle have combined
to subject bank loan credit spreads to relentless downward pressure, both on an absolute
basis and relative to other asset classes.

11.7 Keywords

Collateralized Debt Obligations: CDOs are specialized repackaged offerings that typically involve
a large portfolio of credits.
Credit Derivatives: Credit derivatives are derivative contracts that seek to transfer defined
credit risks in a credit product or bunch of credit products to the counterparty to the derivative
contract.

Creditworthiness Risk: Creditworthiness risk is defined as the risk that the perceived
creditworthiness of the borrower or the counterparty might deteriorate, without default being
a certainty.

Mezzanine Debt: That portion of funding, which has debt in ascending order of risk weights, or
in descending order of ratings.
Securitization: The process through which an issuer creates a financial instrument by combining
other financial assets and then marketing different tiers of the repackaged instruments to investors.
Senior Debt: That portion of funding, which has the lowest risk weight, or the highest rated debt.

11.8 Review Questions

1. Credit derivatives are derivative contracts that seek to transfer defined credit risks in a
credit product or bunch of credit products to the counterparty to the derivative contract.
Discuss.
2. The easiest and the most traditional form of a credit derivative is a guarantee. What are the
other types of credit derivatives?

3. Write a note on credit default swaps.
4. Discuss the functioning of CDOs with suitable examples.
5. Analyse the scope and growth of credit derivatives in India.
6. Make a strategy for credit risk mitigation in banks.
7. What is weather derivative? Give some examples of weather hedging.

8. Discuss the mechanics of Total Return Swaps.
9. Define creditworthiness risk.
10. State the difference between credit derivatives and financial derivatives.

Answers: Self Assessment

1. 1993-94 2. credit risks

3. option 4. funded form
5. repack 6. True
7. False 8. False

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