Evaluating credit protection

Determining the amount of protection provided by a credit derivative is subjective,
as the terms of the contract will allow for varying degrees of loss protection. Manage
ment should complete a full analysis of the reference obligor(s), the counterparty, and
the terms of the underlying credit derivative contract and document its assessment of
the degree of protection. Table 11.5 highlights items to consider.

Banks selling credit protection assume reference asset credit risk and must
identify the potential for loss, they should risk rate the exposure based on the
financial condition and resources of the reference obligor.
Banks face a number of less obvious credit risks when using credit derivatives.
They include leverage, speculation, and pricing risks.