Credit derivatives are financial contracts that allow one party to transfer the credit risk of an underlying asset to another party. They are commonly used by investors to hedge against potential losses from defaults or credit events related to borrowers, such as corporations or governments. The most common type of credit derivative is a credit default swap (CDS), which functions like insurance against default. In a CDS, the buyer pays a premium to the seller, who agrees to compensate the buyer if the underlying borrower defaults. This helps manage risk in financial markets.