In this article, we introduce the very basics of Credit Default Swaps, Total Return Swaps, Credit-Linked Notes and Collateral Debt Obligations. In general, credit derivatives are instruments used by financial institutions to manage their credit risk. Credit risks arise because of the possibility that financial claims, such as loans or bonds, will not be repaid in full.

Credit Default Swaps (CDS)

The concept behind credit default swaps is identical to that of insurance where you pay the insurer a fixed sum of money periodically in order to protect a reference entity against future risks. Typically, this would be your car, house or health. In the case of CDS, the reference entity is now a loan or bond which has been made or purchased by a financial institution. To protect against the risk of default, the financial institution similarly pays a fixed periodic sum to an insurer (usually another financial institution) ......