Editing Credit derivative (section)

== Types ==
Credit derivatives are fundamentally divided into two categories: funded credit derivatives and unfunded credit derivatives.

An '''unfunded credit derivative''' is a bilateral contract between two counterparties, where each party is responsible for making its payments under the contract (i.e., payments of premiums and any cash or physical settlement amount) itself without recourse to other assets.

A '''funded credit derivative''' involves the protection seller (the party that assumes the credit risk) making an initial payment that is used to settle any potential credit events. (The protection buyer, however, still may be exposed to the ''credit risk'' of the ''protection seller'' itself. This is known as counterparty risk.)

Unfunded credit derivative products include the following products:
* [[Credit default swap]] (CDS)
* [[Total return swap]]
* [[Constant maturity credit default swap]] (CMCDS)
* First to Default Credit Default Swap
* Portfolio Credit Default Swap
* Secured Loan Credit Default Swap
* Credit Default Swap on Asset Backed Securities
* Credit default [[swaption]]
* Recovery lock transaction
* Credit Spread Option
* CDS index products

Funded credit derivative products include the following products:
* [[Credit-linked note]] (CLN)
* Synthetic [[collateralized debt obligation]] (CDO)
* [[Constant Proportion Debt Obligation]] (CPDO)
* Synthetic [[constant proportion portfolio insurance]] (Synthetic CPPI)

=== Key unfunded credit derivative products ===

==== Credit default swap ====
{{Main|Credit default swap}}
The credit default swap or CDS has become the cornerstone product of the credit derivatives market.  This product represents over thirty percent of the credit derivatives market.<ref name="BBACDR"/>

The product has many variations, including where there is a basket or portfolio of reference entities, although fundamentally, the principles remain the same.  A powerful recent variation has been gathering market share of late: credit default swaps which relate to asset-backed securities.<ref>{{cite web  |last1=Parker |first1=Edmund |last2=Piracci |first2=Jamila |url=http://www.mayerbrown.com/london/article.asp?id=3517&nid=1575|title=Documenting credit default swaps on asset backed securities |publisher=Mayer Brown |date=April 19, 2007 |archive-url=https://web.archive.org/web/20110521170516/http://www.mayerbrown.com/london/article.asp?id=3517&nid=1575 |archive-date=May 21, 2011 }}</ref>

==== Total return swap ====
{{Main|Total return swap}}

=== Key funded credit derivative products ===

==== Credit linked notes ====
[[Image:Securitization-en.PNG|thumb|right|400px|In this example coupons from the bank's portfolio of loans are passed to the SPV which uses the cash flow to service the credit linked notes.]]
A credit linked note is a note whose cash flow depends upon an event, which may be a default, change in credit spread, or rating change. The definition of the relevant credit events must be negotiated by the parties to the note.

A CLN in effect combines a credit-default swap with a regular note (with coupon, maturity, redemption).  Given its note-like features, a CLN is an on-balance-sheet asset, in contrast to a CDS.

Typically, an investment fund manager will purchase such a note to hedge against possible down grades, or loan defaults.

Numerous different types of credit linked notes (CLNs) have been structured and placed in the past few years. Here we are going to provide an overview rather than a detailed account of these instruments.

The most basic CLN consists of a bond, issued by a well-rated borrower, packaged with a credit default swap on a less creditworthy risk.

For example, a bank may sell some of its exposure to a particular emerging country by issuing a bond linked to that country's default or convertibility risk. From the bank's point of view, this achieves the purpose of reducing its exposure to that risk, as it will not need to reimburse all or part of the note if a credit event occurs. However, from the point of view of investors, the risk profile is different from that of the bonds issued by the country. If the bank runs into difficulty, their investments will suffer even if the country is still performing well.

The [[credit rating]] is improved by using a proportion of government bonds, which means the CLN investor receives an enhanced coupon.

Through the use of a credit default swap, the bank receives some recompense if the reference credit defaults.

There are several different types of securitized product, which have a credit dimension.
* [[Credit-linked note]]s (CLN): Credit-linked note is a generic name related to any bond whose value is linked to the performance of a reference asset, or assets. This link may be through the use of a credit derivative, but does not have to be.
* [[Collateralized debt obligation]] (CDO): Generic term for a bond issued against a mixed pool of assets—there also exists [[CDO-Squared]] (CDO^2) where the underlying assets are CDO tranches.
* [[Collateralized bond obligation]]s (CBO): Bond issued against a pool of bond assets or other securities. It is referred to in a generic sense as a CDO
* [[Collateralized loan obligation]]s (CLO): Bond issued against a pool of bank loan. It is referred to in a generic sense as a '''CDO'''

CDO refers either to the pool of assets used to support the CLNs or the CLNs themselves.

==== Collateralized debt obligations  ====
{{main|collateralized debt obligation}}
Not all collateralized debt obligations (CDOs) are credit derivatives. For example, a CDO made up of loans is merely a securitizing of loans that is then tranched based on its credit rating. This particular securitization is known as a collateralized loan obligation (CLO) and the investor receives the cash flow that accompanies the paying of the debtor to the creditor. Essentially, a CDO is held up by a pool of assets that generate cash.  A CDO only becomes a derivative when it is used in conjunction with credit default swaps (CDS), in which case it becomes a [[Synthetic CDO]]. The main difference between CDOs and derivatives is that a derivative is essentially a bilateral agreement in which the payout occurs during a specific event which is tied to the underlying asset.

Other more complicated CDOs have been developed where each underlying credit risk is itself a CDO [[tranche]]. These CDOs are commonly known as CDOs-squared.