Credit Derivatives

Abstract

It has been widely believed that banks are safe enough to handle their own risks and do what they should to as members of society in Korea. After Jun 2008, global financial crisis made us think even banks are not safe and could be bankrupt with huge social damage. With all these consequences, credit derivatives are pointed as an axis of evil. The greed of financial institutions like banks, insurance companies, investment companies and private investors is told to be cause of these hazardous financial instruments

credit derivatives. But we need to see from the origin, not just consequences before we judge these financial instruments. Credit derivatives are derivatives with linkage of their price on reference assets status like credit rank, cash flow. When credit events happens, these instruments work as insurance options for protect buyer. It has been only 15 years for credit derivatives known to the public but, within 15 years, the size of contracts(notional amount) of credit derivatives has been soared 100 times. From CDS(Credit Default Swap) as a basic credit derivative to synthetic CDOs(Collateralized debt obligations) as highly structured financial instrument, these credit derivatives has introduced to Korea in 1997 by foreign investment banks. The size of contract has been enlarged from 30 million KRW in 1998 to 6 trillion KRW in 2011. This paper examined how these credit derivatives affect manufacturing and non-manufacturing industries on the matter of cost of debt capital. By TS2000 data base for industry variables, we examined 504 samples which consist of 36 KIS-9 classification middle class industries in 14 years from 1998 to 2011. By measuring control variables such as industry size , beta, debt ratio, ROA and independent variables such as CreditDerivativeRatio(total notional amount of credit derivatives divided by total amount of loans held by banks) to examine the effect of credit derivatives on the cost of debt capital. Credit derivatives ratio works in negative direction on the cost of debt capital but the effects are different. In manufacturing industry, credit derivative has its smoothing effect with ROA on cost of debt capital. But in non-manufacturing industry, credit derivative has its smoothing effect with asset size on cost of debt capital. In Korea, Credit derivatives like CLN and Synthetic CDOs are getting famous with their characters to meet customers target yield with adequate control. Increasing usage of credit derivatives are irreversible stream in global finance market, so we need to renew our perceptions on credit derivatives and think wisely toward the future of Korean financial market