Loan Credit Default Swap
A loan credit default swap (LCDS) is a type of credit derivative in which the credit exposure of an underlying loan is exchanged between two parties. A loan credit default swap's structure is the same as a regular credit default swap (CDS), except that the underlying reference obligation is limited strictly to syndicated secured loans, rather than any type of corporate debt.
Loan credit default swaps can also be referred to as “loan-only credit default swaps. ”
Loan Credit Default Swap (LCDS)
Definition
A Loan Credit Default Swap (LCDS) is a type of credit derivative where the credit risk of an underlying loan is exchanged between two parties. The structure of an LCDS is similar to a regular Credit Default Swap (CDS), with the key difference being that the underlying reference debt is limited to specific syndicated loan guarantees, excluding any type of corporate debt.
Origin
The Loan Credit Default Swap originated in the late 1990s, evolving with the development of the credit derivatives market. Initially, CDS was primarily used for managing the credit risk of corporate debt, but as market demands changed, LCDS emerged as a tool specifically for syndicated loans.
Categories and Characteristics
Loan Credit Default Swaps are mainly divided into two categories: single-loan credit default swaps and portfolio loan credit default swaps. Single-loan credit default swaps target the credit risk of a specific syndicated loan, while portfolio loan credit default swaps involve the credit risk of multiple syndicated loans.
- Single-Loan Credit Default Swap: This type of LCDS targets a specific syndicated loan, suitable for investors looking to manage the risk of a particular loan.
- Portfolio Loan Credit Default Swap: This type of LCDS involves multiple syndicated loans, suitable for investors looking to diversify risk.
Specific Cases
Case 1: A bank holds a syndicated loan for a large corporation and is concerned about the corporation's potential default. The bank purchases an LCDS to transfer the credit risk of the loan to another party (e.g., a hedge fund). If the corporation defaults, the hedge fund compensates the bank.
Case 2: An investment firm holds a portfolio of syndicated loans and is concerned about overall market risk. The firm purchases a portfolio loan credit default swap to spread the credit risk of these loans among multiple counterparties, thereby reducing overall risk.
Common Questions
Question 1: How does an LCDS differ from a CDS?
Answer: The underlying reference debt in an LCDS is limited to syndicated loans, whereas a CDS can include any type of corporate debt.
Question 2: What are the risks of investing in LCDS?
Answer: The main risks include counterparty default risk, market liquidity risk, and the risk of default on the underlying loan.
