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Part - II

Although the credit derivatives market hasn't caught fire in the last few months, there's evidence of slow, solid growth. "It is getting busier now," says Intercapital's Crammond, who estimates his firm does anywhere from 30 to 70 serious inquiries a week. "We can count on three out of five days being extremely hectic-and that's a great development. Intercapital has hired six full-time credit derivatives specialists over the past year to build a credit desk from scratch. They are now in the process of computerizing all the inquiries it receives to help us identify market trends."

There's also evidence of an increasingly balanced two-way market for credit exposure-supported by investors who want to buy credit risk and hedgers who want to lay it off. "We are seeing more speculative positions which, to a certain extent, are coming from traders who are experiencing management pressure to generate profits. And, as more people begin to understand credit derivatives, we are also seeing more hedging in the credit markets," says one New York-based broker. He notes that much of the hedging transactions are coming from large corporate lenders who are attempting to hedge the concentration risk associated with their loan portfolios.

And dealers are rushing to jump on the credit derivatives bandwagon. Paul Colello, who heads up Credit Suisse Financial Products' derivatives desk in New York, estimates that there are now 15 dealers willing to quote prices in basic products. Recent entrants include Merrill Lynch, Lehman Brothers, Citibank and Bank of Montreal, while "old hands" in the credit derivatives arena include JP Morgan, Bankers Trust, CSFP, Chase Manhattan, Bear Stearns and CIBC Wood Gundy.

Strategically speaking, most dealers are trying to remain generalists in the credit derivatives market because, so far, no one knows which particular structure will be the next to "take off." Right now, the "meat and potatoes" of credit derivatives include default swaps, total return swaps and credit-linked notes. (See box above.) More exotic structures may pay out based on the behavior of a basket of reference credits, change character over time or include multiple contingencies. As with any species of derivative, the only limitation to potential credit structures is the imagination of financial engineers. And typically, most of these exotic structures are custom-tailored to the specific needs of individual clients.

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* Contributed by -
Prashant Jadhav,
2nd Year PGeMBA (Finance),
Mumbai Educational Trust (MET) Schools of Management, Mumbai.