Credit derivative

Usually these contracts are traded pursuant to an International Swaps and Derivatives Association (ISDA) master agreement.

The market in credit derivatives as defined in today's terms started from nothing in 1993 after having been pioneered by J.P. Morgan's Peter Hancock.

[5] 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.

A CLN in effect combines a credit-default swap with a regular note (with coupon, maturity, redemption).

Numerous different types of credit linked notes (CLNs) have been structured and placed in the past few years.

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.

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.

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

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.

The US Federal Reserve issued several statements in the Fall of 2005 about these risks, and highlighted the growing backlog of confirmations for credit derivatives trades.