For this type of credit derivative, traditional credit risk may reappear as counterparty credit risk, that is, the risk that the bank’s counterparty will not fulfill its agreement to compensate the bank in case of a credit loss.
The price of a credit derivative should take into consideration the credit risk posed by the seller of the protection and the appropriate default correlation, though default correlations are difficult to estimate precisely. But some credit derivatives, such as credit-linked notes, are prefunded--the counterparty pays the principal up front and the repayment it receives at maturity is contingent on a credit event not occurring.