Delivery Option: The Link Between Futures and Credit Derivatives
Credit derivatives, which began as a means of hedging the loan exposure of banks, have taken on a life of their own. Now they are used for many purposes for which they were not originally designed.
For example, some investors use derivatives to construct synthetic corporate bonds. As current convention has it, this is done with two instruments: a credit default swap (CDS) and an interest rate swap. The credit default swap is a contract in which one party sells default protection to another. The interest rate swap is a contract in which one party makes interest payments at a fixed rate and the other makes payments at a floating rate. One would create a basis trade by exchanging ...