The new capital adequacy framework under design leaves more room for the application of internal ratings and internal risk management systems. After analyzing credit risk, the question rises how credit risk is incorporated in loan prices. Aside from credit risk in debt instruments, we'll focus on measuring credit risk in derivative instruments, like swaps and forwards. At the end of 1990, Bankers Trust developed the concepts of basket credit default options, credit swaps and total return swaps. Since then, the market for credit derivatives has shown a tremendous growth, both in volume and in the range of available products.
Credit derivatives offer a systematic way of evaluating and transferring credit risk.
Circumventing some of the disadvantages of cash market transactions, banks and other financial institutions can use credit derivatives to dynamically manage their credit risk exposure to selected counterparties. In addition, credit derivatives allow lenders and investors to achieve credit exposures not otherwise available to them. We will provide a typology of credit derivatives and show how they can be priced and be applied to adjust credit risk exposures. Over the last five years various systems to analyze, measure and manage credit risk have emerged. The literature of the course consists mainly of papers from both academic journals and practitioner's journals, like Journal of Finance, Journal of Derivatives, RISK, Financial Analysts Journal etc.