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What are credit derivatives?
Stemming from the hedging strategy of Credit Default Swaps, an entire speculative derivatives market continues to grow, in which tranches of credit risk and indices are traded.
With the ballooning of consumer credit in recent years, it is only natural that a credit derivatives market would follow it.
In essence, the risk associated with a loan or bond is separated from the actual asset and is passed on to a counter-party for a premium, and then other market participants become involved, perhaps in the form of futures contracts or other derivatives.
Tranches of naked credit default swaps are sliced up based on risk, and traders can go long or short on these positions. They might be traded based on movements in credit spreads or other factors. The Credit Derivatives market trades Over-the-Counter (OTC) and is flexible in ways not permitted by the bond market, making it a popular play for hedge fund managers.
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