Credit Derivative

Credit derivative is a financial instrument whose value is determined by the underlying "credit risk" of the financial asset like the bond or loan.

Credit Risk is used to transfer the risk from one party to another in case if a credit event. Let us say that Party A gives loan to party B (reference party). Party A, to secure itself against a default from party B takes insurance from another Paty C.

The most commonly used credit derivative is the 'credit derivate swap' where the credit risk is swapped between 2 parties. Party A makes regular payment (premium) to party C but party C makes no payment unless there is a credit event. In case B is not able to repay the loan, partt C makes payment to A and then the swap terminates. The amount of payment made is generally the decline in the market value of the reference asset.

http://www.finpipe.com/crederiv.htm