The development of the credit derivatives market, and hence the subsequent introduction of structured credit products, was a response to the rising importance attached to credit risk management. For this reason, we believe it is worthwhile beginning this book with a look at credit risk, credit risk transfer and credit ratings from first principles.
1.1 The Concept of Synthetic Investment
If one stops to consider it, banks have been ‘selling protection’ on their customers ever since they began formally borrowing and lending amongst their customers in the Italian city-states during the Middle Ages. We describe how.
A Bank lends 100 florins to Mr Borrower for a period of 5 years, who agrees to pay interest of C% per ...