A sort of put option which is linked to the credit worthiness of a borrower. The holder of the option receives a certain payoff if the credit rating of a bond issued drops below a preset strike level. The option’s strike level and payout are typically related to some quantitative and qualitative aspects of the issuer’s business such as: credit rating, financial ratios (e.g., debt-to-equity ratio,..), rate spreads, etc. As a result, the option’s price depends mainly on changes in a borrower’s capital structure, the interest rate structure, and credit spreads.
December 16, 2024
