Credit derivatives are contractual agreements that provide insurance against a credit event of one or more referenced credits. The nature of the credit event is established by the buyer and seller at the inception of the transaction, and such events include bankruptcy, insolvency and failure to meet payment obligations when due. All derivatives are subject to market risk, representing potential loss due to adverse movements in the underlying instrument. Market risk is reduced by entering into offsetting positions using other financial instruments. Credit risk arises primarily from OTC contracts, since exchange-traded contracts are generally settled daily.
Credit risk is reduced significantly by entering into legally enforceable master netting agreements.
To further reduce exposure, management may obtain collateral. The amount and nature of the collateral obtained are based on management's credit evaluation of the customer. Collateral held varies but may include cash, securities, accounts receivable, inventory, property, plant and equipment, and real estate. Co. All Rights Reserved.