In finance, a credit derivative refers to any one of "various instruments and techniques designed to separate and then transfer the credit risk" of the underlying loan. It is a securitized derivative whereby the credit risk is transferred to an entity other than the lender.
Where credit protection is bought and sold between bilateral counterparties, this is known as an unfunded credit derivative. If the credit derivative is entered into by a financial institution or a special purpose vehicle (SPV) and payments under the credit derivative are funded using securitization techniques, such that a debt obligation is issued by the financial institution or SPV to support these obligations, this is known as a funded credit derivative.
This synthetic securitization process has become increasingly popular over the last decade, with the simple versions of these structures being known as synthetic CDOs; credit-linked notes; single tranche CDOs, to name a few. In funded credit derivatives, transactions are often rated by rating agencies, which allows investors to take different slices of credit risk according to their risk appetite.
Read more about Credit Derivative: History and Participants, Types, Pricing, Risks
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