Enron Case

Enron Case

1.       A credit derivative is a bilateral contract that allows one party to transfer the risk of the asset to another entity in case they are afraid that they may not receive their investment back from a borrowing party. This technique is a good way to help protect oneself against credit risk.

2.        Management of a firm’s own credit risk is very important to its derivatives operations. The reason being that if they have poor credit risk management, then that could lead to defaults for the company. This would hurt the credit rating of the company which in turn would hurt the number of investors willing to loan money to the organization. If they can no longer generate capital for needed operations, then the company will struggle to function in the future.

3.       There are many different approaches that financial institutions use in order to manage and control the level of credit risk they undertake. Firms typically have departments set up whose main purpose is to evaluate the financial well-being of potential clients and determining if they should extend credit to them based on the likelihood that they will be paid back. A Credit scorecard is also a tactic a company may use to manage risk. This will help them rank customers by the level of risk they possess in order to determine who to lend to. Companies may also reach out to other firms for evaluation assistance on the credit risk of a particular investment. For a bondholder, one method of protection against credit risk was to use poison puts on a bond. This allows them to sell their bond back at par if a special event occurred that they feel might not have been positive for the future. The better a firm can understand the level of risk a potential investment may carry, the better they can manage and decide if they want to follow through with that client. Managing credit risk comes down to finding the right investments that will provide a probable return.

4.        There are various...