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Unformatted text preview: Letters of Credit - Commitment by a bank on behalf of a buyer that payment will be made to a third party - A guarantee Derivative Contracts - Futures, forwards, swaps, options and credit derivatives o Use by FIs for hedging o FIs act as dealers o Counterparty risk (default on payment obligations) o OTC markets (high counterparty risk), Organised exchanges (low counterparty risk) o Credit derivatives CDSs, CDOs Valuing OBS Items - Where option-like features; use contingent claim/option pricing theory models - () - Holder of loan commitment has option to borrow- Buyer of letter of credit has an option to default- For swaps, futures and forwards convert into an equivalent value of underlying assets Role of OBS - Hedging exposures - Fee income - Expanded use of derivatives poses risks to the financial system...
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- Three '09