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5.2 Credit derivatives

Even if credit derivatives are not commonly traded in open markets, they are often embedded with bonds to create the flexibility needed by the lenders and borrowers. A 10 years loan, for example, offered by a bank to an individual who buys an apartment for the payment of a fixed 5% interest, can generally be cancelled without penalty at any time. To make this possible, the bank sells a bond with a 5% coupon embedded with an American call option-a product known as a callable bond. The money may however originally come from a deposit made at floating LIBOR rates and can be tailored to fixed rates using a swap.



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