Credit derivatives help corporations manage indirect costs related to their business activities.
Reduce interest expense.
Issuers can synthetically tender for their bonds. The synthetic tender provides the economics of a long position in a company's own bonds without the potentially negative tax and book consequences that can accompany a cash market repurchase. Additionally, the synthetic tender provides cheap leverage while maintaining liquidity.
Regulatory Arbitrage.
Currently, the capital charges imposed on banks for the types of credit risks held on their books is not commensurate with the specific credit risk. For example, all unsecured corporate credit obligations are 100% risk weighted by the BIS. Banks can reduce the capital charge by hedging a high-rated, low margin exposure using a default swap with regulated broker dealer counterparty.
Tax management.
An insurance company with a large capital gain in a corporate bond position can hedge the gain by using (paying) a total return swap on the bond and receiving a floating rate cash flow. This hedge is effectively equivalent to a sale of an asset with a gain, but a tax event is averted since the bond is not sold.
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