7Applications of Credit Derivatives and Financial Engineering

In the previous chapters, we defined credit risk and priced credit risk, and showed some of the products that have been developed whose values are tied directly to credit risk (CDS, CDO, and so on). In this chapter, we focus on the applications of financial instruments that have credit risk embedded in them.

One of the most obvious uses of credit-sensitive products1 is to simply use these products for investment purposes; that is, an investor can invest in a credit default swap (that is, assume one leg of a CDS transaction) or the equity or various tranches of debt in a CDO for speculative purposes. Thus, these products offer investors a quick and efficient way to gain credit risk ...

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