An Introduction to Bond Markets, Fourth Edition

Chapter 12

INTRODUCTION TO CREDIT DERIVATIVES

Perhaps the most significant development to have taken place in debt capital markets since the first edition of this book was published is the growth in use of credit derivative instruments. At the time of writing of the first edition, these products had been introduced in both the US and London markets; however, they were not a liquid product and were viewed as more of a risk management tool for banks than a brand new investment product in their own right. They should now be viewed in a more important light.

 

An article in the 15 March 2003 issue of The Economist reported that credit derivatives were used by just 0.2% of American banks. This implies that they are not vital or important instruments in the financial markets. In a way, this would be a reasonable conclusion to make. However, while this figure is undoubtedly higher now, its absolute value is not really relevant. The importance of credit derivatives lies in the potential they generate for greater transparency and disintermediation for the market as a whole: transparency with regard to asset valuation, liquidity and accessibility. Greater transparency and liquidity for just a small percentage of the market - typically, the largest banks and securities houses that take on and manage credit risk - works through into better trading conditions for all market participants. This then is the new paradigm shift currently taking place in credit markets, brought about by the isolation ...