A look through Credit Linked Notes

Fixed income today is again attractive given current yields, in this regard we look at an alternative on the issue of fixed income: Credit Linked Notes.
Credit Linked Notes (CLN) are structured financial instruments that offer exposure to the credit risk of a specific entity, such as a company or country.

These securities are therefore nothing more than bonds in which indexation refers not to cash flows but to the credit risk of securities.
Typically, in exchange for exposure to specific credit risks, investors who purchase debt securities get a higher rate of return than other bonds.

Typically, CLNs are issued by a bank or fund and are sold to investors as fixed income securities.

The use of a credit default swap, one of the underlying options of the CLN, allows you to sell the risk associated with default to other parties and provides the same functionalities of an insurance. Investors generally receive a higher rate of return than other obligations as compensation for the additional risk associated with the security. In the event of default, all parties involved are at risk of loss.

The yield of a CLN is generally very attractive and clearly higher when compared to single bonds. However, a higher return brings with it as always even greater risk, therefore, the investor bears a double credit risk, that relating to the underlying and that of the issuer.

The CLN allows two main things:

  • investors to indirectly acquire credit exposures to entities that are traditionally outside their scope
  • the involved financed intermediaries, to carry out a more active and efficient management of their credit risk

The underlying of a Credit Linked Notes (CLN) can be very varied, depending on the specific structure of each CLN issue. Generally, the most common are CDS, or Credit Default Swaps, but here are some more:

  • Bonds issued by a company or by government
  • Residential or commercial loans
  • Securitisation of loans or debts
  • Credit indices, such as iTraxx or CDX

This is not financial advice and before investing in CLN or any other financial instrument, it is important to pay attention and understand the associated risks and consult a qualified professional.

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