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Topic_19_E2 - Topic 19 Exercise 2 Hedging Credit Risk In...

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Topic 19, Exercise 2 Hedging Credit Risk In today’s market, financial and risk managers have a wide variety of options to control risk. One of the more interesting developments in this arena is the creation of instruments that can be used to control or manage default risk. These instruments are used by fixed-income investors, banks and corporations funding purchases of other corporations. A recent Economic Letter from the Federal Reserve Bank in San Francisco entitled, “Financial Instruments for Hedging Credit Risk,” describes the basic types of instruments used to manage default or credit risk. After reading this article, answer the following questions: 1. What are the two main categories of instruments used to mitigate credit risk? Briefly describe each of the categories. The author identifies two main categories: credit derivatives and collateralized debt obligations (CDOs). When credit derivatives are used, the credit remains on the balance
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