Credit instrument it is contracts in financial area between two parties or more regarding a right to payment of money. Those monetary contracts allow users to handle their exposure to credit risk. It could be currency in cash, share - evidence of an ownership interest in an entity or bond what it means a contractual right to receive or deliver cash.
Types of credit instrument
In literature it is distinguish several types of credit instrument for instance (A. N. Bomfim, 2015, s.5-9):
- Single-Name Instruments - include protection against insolvency. Example of Single-Name Instruments are the credit default swap (CDS), asset swaps,total return swaps (an investor without buying and owning the asset or the index receive all the cash flows associated with a given reference assets or financial index), spread and bond options (Spread and bond deviate of norms which are based on final payoffs are essentially tied to default event involving the reference entity. Spread options payoffs are specified in terms of the performance of a reference assets relative to that of another asset. Bond options we can buy or sell it in a good time of their price).
- Multiname Instruments - contracts which allow to mixed credit risk associated thanks to portfolio of defaultable securities instead to dealing in each of security portfolio separately. For example, first-to-default basket swap or portfolio default swap.
- Credit-Linked Notes (CLN)- can be assume that it is regular debt obligation with an embedded credit derivatives.
- Sovereign vs. Other Reference Entitle - can reference in private sector (for example corporates) or sovereign nation. For instance agrees for sovereign debtors can include moratorium and debt repudiation as credit events, whereas contracts that reference corporate debt are not allowed similar demeanour.
Another Types of credit derivatives: Repackaging Vehicles; Synthetic CDOs; CDS Indexes; CDS on Credential Mortgages and Subprime Residential Mortgages(A. N. Bomfim, 2015, s.43-148).
Macroprudential instruments should introduced to reducing risk of systemic, in two types over time or across institutions and markets. Using macroprudential instruments (C. H. Lim, A. Costa, F. Columba,P. Kongsamut, A. Otani, M. Saiyid, 2011, s.4-5)
- Single versus multiple - use of different instruments can be more effective and shows different aspects of the same risk
- Broad-based versus targeted - Usage of differentiating transaction makes more precise and more effective the instruments are.
- Fixed versus time-varying - in case where we diversificate instruments in different part of the cycle, it is possible to achieve more effective financial cycle.
- Rules versus discretion - clear advantages and effective are rules-based adjustment like a dynamic provisioning
- Coordination with other policies - More effective is to mixed instruments with monetary or fiscal policy tools. It caused reinforcement reaching goals.
- Bomfim, A. N. (2015), Understanding credit derivatives and related instruments. Academic Press.
- Kalemanova A. , Mayer B. , Zagst R., (2015) Asset Allocation with Credit Instruments, Munich University of Technology.
- Lim, C. H., Costa, A., Columba, F., Kongsamut, P., Otani, A., Saiyid, M., (2011), Macroprudential policy: what instruments and how to use them? Lessons from country experiences. IMF working papers, 1-85.
Author: Karolina Knapik