Credit Risk Transfer Mechanisms (FRM Part 1 2025 – Book 1 – Chapter 4)

Ace FRM Part 1 – Book 1, Chapter 4: Credit Risk Transfer Mechanisms. In this lecture, Prof. Forjan explains how institutions transfer, hedge, and price credit risk using OTC derivatives and securitization.

What you’ll learn:
Credit derivatives overview and why they exist
CDS (structure, uses, pros/cons)
CDOs vs CLOs and tranche waterfalls
2007–2009 crisis lessons (what failed and why)
Total Return Swaps & CDS swaptions
Traditional mitigation: insurance, netting, MTM, termination
Securitization & SPVs

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After completing this reading you should be able to:
Compare different types of credit derivatives, explain how each one transfers credit risk and describe their advantages and disadvantages.
Explain different traditional approaches or mechanisms that firms can use to help mitigate credit risk.
Evaluate the role of credit derivatives in the 2007-2009 financial crisis and explain changes in the credit derivative market that occurred as a result of the crisis.
Explain the process of securitization, describe a special purpose vehicle (SPV) and assess the risk of different business models that banks can use for securitized products.

0:00 Introduction
0:53 Learning Objectives
1:20 Overview of Credit Risk Management
7:09 Credit Derivatives in 2007/2009
9:04 Credit Default Swaps (CDS)
19:04 CDS Manipulation: Illustration
20:33 Collateralized Debt Obligations (CDO)
27:39 Collateralized Loan Obligations
28:01 Total Return Swap
33:15 Credit Default Swap Option
34:44 Traditional Risk Mitigation Techniques
36:48 Securitization
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