Reference Obligation

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Definition of 'Reference Obligation'
The specific underlying debt upon which a credit derivative is based. A reference obligation is issued by the reference entity. It does not represent all the forms of debt issued by the entity, but only a specific issue. Often, this obligation is the actual security that the credit derivative was created to hedge.

Investopedia explains 'Reference Obligation'
The reference obligation is the specific issue of a debt security upon which the two parties in the credit derivative transaction are betting against each other. If the reference entity defaults on this issue (or another specific, agreed-upon event occurs), the buyer receives a payout. If no triggering event occurs to the reference obligation, the seller of the credit derivative profits from the premium paid by the buyer.

Definition of 'Reference Asset'
An underlying asset used in credit derivatives, which are then used when there is a risky debt issuer, such as a corporation or municipality. In a credit derivative, the buyer purchases protection against the chance of default by the risky borrower by buying the reference asset. Investopedia explains 'Reference Asset'
When an entity issues debt or borrows money, there is a chance that it will not repay the funds, which is called default risk. The debt holder is always exposed to risk by the borrower defaulting on the debt.

To hedge this risk, the debt holder can enter into a credit derivative, such as a total return or credit default swap. The swap allows the debt holder to transfer the risk they are exposed to to a third party.