What are 'credit derivatives' used for?

What are 'credit derivatives' used for?

• A. To manage exposure to equity risk
• B. To manage exposure to credit risk
• C. To guarantee fixed interest rates
• D. To simplify mortgage processing

Answer: (B)

Credit derivatives are financial instruments designed specifically to transfer and manage exposure to credit risk. They allow parties to hedge against the risk of default on a loan or other credit obligation. By using credit derivatives, institutions can protect themselves from losses that might occur if a borrower fails to meet their repayment obligations. In essence, these derivatives enable a range of financial strategies, including risk transfer and speculation on credit events, without requiring the owner to actually hold the underlying asset. This structure helps in improving liquidity and managing risk more effectively in the financial markets. The other options focus on different types of risk and instruments. For example, equity risk relates to stock market fluctuations, fixed interest rates pertain to interest rate derivatives, and mortgage processing simplification does not directly connect to credit hedging.

Credit derivatives are financial instruments designed specifically to transfer and manage exposure to credit risk. They allow parties to hedge against the risk of default on a loan or other credit obligation. By using credit derivatives, institutions can protect themselves from losses that might occur if a borrower fails to meet their repayment obligations.

In essence, these derivatives enable a range of financial strategies, including risk transfer and speculation on credit events, without requiring the owner to actually hold the underlying asset. This structure helps in improving liquidity and managing risk more effectively in the financial markets.

The other options focus on different types of risk and instruments. For example, equity risk relates to stock market fluctuations, fixed interest rates pertain to interest rate derivatives, and mortgage processing simplification does not directly connect to credit hedging.