credit linked notes

Question 1

definition

Answer 1

• combine a bond with a credit default swap (CDS), allowing the issuer to transfer credit risk to the investor.

Question 2

what are the two components?

Answer 2

• Bond Component: Investors receive periodic interest payments and principal at maturity, similar to a regular bond.
• Credit Derivative Component: Embedded CDS specifies a reference entity and a credit event (e.g., default, restructuring). If the credit event occurs, investors may lose part or all of their principal.

Question 3

what are the uses?

Answer 3

• Risk Management: Financial institutions use CLNs to manage and offload credit risk.
• Yield Enhancement: Investors seeking higher returns invest in CLNs for the additional yield.
• Credit Exposure: Provides exposure to the credit risk of specific entities without directly investing in their bonds.

Question 4

what are the risks?

Answer 4

• Credit Risk: Investors bear the credit risk of the reference entity.
• Complexity: CLNs have complex structures, suitable for sophisticated investors.
• Liquidity Risk: They may be less liquid than traditional bonds, making it harder to sell before maturity.