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Credit enhancement
encompasses a variety of provisions that may be used to reduce the credit
risk of an obligation. Credit enhancements are often incorporated into
OTC derivatives, corporate debt,
securitized debt and other instruments.
Techniques of credit enhancement include:
 collateralization: One or more parties may agree to
post collateral. Collateral levels may be fixed or vary over time to
reflect the market value of different
parties' obligations.
third party loan guarantees: A parent company or other
third party may be contractually bound to meet the obligations of one
party should that party default.
credit insurance: An insurance policy may provide for
compensation in the event that a party defaults.
letters of credit: A bank may confirm financing.
special
purpose vehicle: One party may enter into the
deal through its own over-capitalized, bankruptcy remote subsidiary. Other techniques may sometimes
also be referred to as credit enhancement. These include
netting
agreements, credit downgrade triggers, and bundling with credit
derivatives.
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