The primary types of risks faced by institutions engaged in finacial transactions are credit risk and market risk. In recent years a great deal of attention has been placed on credit risk. To manage credit risk, new financial instrument called credit derivatives have been developed in the past few years. Credit derivatives are financial contracts that provide insurance against credit-related losses. They also allow the separate trading and the pricing of credit risk
This paper introduces basic concept and advantages of credit derivatives and summarizes risks involved with credit derivatives and various types of credit derivatives currently available in the market. In addition, this paper provides the pricing methods of credit derivatives which are currently used in the market and theoretical pricing models with examples. Finally, it is suggested how to apply credit derivatives more appropriately at domestic financial institutions.
