Credit derivatives’ payouts depend in some way on the creditworthiness of an organisation (which could be a sovereign state, a government body, a financial firm or a corporate). This creditworthiness is gauged by objective financial criteria or a third-party evaluation from a recognised credit rating agency, such as Moody’s Investors Service or Standard & Poor’s.
Credit derivatives might not appear to have an underlying in the conventional sense. But it is often argued that they are based on the cost of a credit event or, equivalently, the premium that would have to be paid to transfer the credit risk of a given transaction to a third party. Most importantly, these derivatives unbundle credit risk from other risks. For example, the holder of a floating-rate note issue can separate the credit risk (that the issuer will default) from the interest rate risk (that the coupon will fall).
There are two main types of credit derivative. The first, which includes credit default swaps (CDS) and put options, activates in the event of a credit event, such as a default or downgrade of debt. A second type of credit derivative is the credit spread forward or option. The underlying for these contracts is the spread between two otherwise identical securities, which depends only on the creditworthiness of the issuer. Swaps under which the total rate of return on an index is swapped for some reference rate are sometimes also referred to as credit derivatives.
Commodity trading and risk management is a subject that is necessarily complicated, and is becoming more so. The Energy Risk Glossary seeks to disentangle and clarify the jargon by providing definitions of commonly used energy and commodity market terms.
These include definitions related to a variety of underlying energy products, as well as technical terms about the many instruments and benchmarks used by energy market participants.
Many of the most recent terms to have been added to our glossary stem from the actions of regulators since the 2008 global financial crisis. The onset of rules, such as the US Dodd-Frank Act and European Market Infrastructure Regulation, has markedly increased the cost and complexity associated with commodity trading. Perhaps they have also increased the need for a handy reference guide such as this.
The glossary is extensively cross-referenced, making for easy and thorough searches. We hope you find the latest edition of the Energy Risk Glossary to be a useful resource.
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