Credit Derivatives and Structured Credit: A Guide for Investors

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The Credit Derivatives and Structured Credit Products Market

Since its emergence, the market in credit derivatives and structured credit products has grown exponentially and most observers agree that this growth should accelerate in the years to come. There are several reasons for this:

• First, the omnipresence of credit risk in the commercial and financial markets (cash and derivatives) means that these instruments offer ample opportunities, in theory greatly superior to interest rate, equity or currency derivatives, among others.
• Second, the emergence of second-generation products (such as ‘exotic’ credit derivatives and structured products) has over the past few years fuelled this market and fostered liquidity in the ‘vanilla’ segments.
• Finally, the recent development of arbitrage operations (particularly via CDOs) has greatly contributed to this steady growth.

Thus, some observers have no hesitation in drawing a parallel between the credit derivatives market and that of interest rate swaps and options. These, unheard of in the early 1980s, have recorded colossal growth since then. Outstanding notional amounts on OTC interest rate derivatives stood at $58 000 bn worldwide at end 1998 (in notional amount) according to the Bank of International Settlements. By the end of 2004 that figure was $187 340 bn! Indeed, the development of these two markets has been very similar: first came standard products (CDS in the former, rate swaps in the latter), then followed by a boom in structured ...