Overview
Many financial instruments contain an element of credit risk. Therefore, whenever a trader trades any of these instruments, she is trading credit to some degree. However, traders can focus on trading a portfolio for the purpose of achieving a particular credit risk profile. This is done for two reasons.
- Hedging - the trader is trying to gain exposure to some other risk, and wishes to eliminate the credit risk. Note that credit derivatives are issued by some party, which itself has credit risk.
- Speculation - the trader believes that the credit risk being traded is over/under priced and is trying to take position.
The purest way to trade credit is through the use of a credit default swap.