Financial instruments that aim to reduce the risk by repackaging corporate debt and reselling them to investors are under pressure from the increased risk of default among debt issuers. The instruments affected are collateralized-debt obligations, or CDOs, and credit-default swaps, CDSs. CDOs represent packages of debt of different risk grade and yield, and CDSs offer hedging against the default of the debt issuer.

The Dow Jones CDX index of investment-grade credit-default swaps rose to 72 basis points, up from 63.25 basis points Monday. The high-yield crossover index was up 25 basis points to 380 to 385.

"It all started real fast," said Raymond Kennedy, high-yield portfolio manager at Pimco. "Investment-grade index products are just getting slaughtered."

This is a real trial for credit-derivative products that lack liquidity as they are not traded on the market, and suffer massive swings from even small movements in the value of the underlying security. So far the market for these innovative products that help diversify risk across investors has not experienced substantial pressures.

Standard & Poor’s aggravated worries about the CDO market by lowering its grade on some of Deutsche Bank’s CDOs and putting the rest of the bank’s CDOs on negative watch. Despite the relatively small size of issues affected by the downgrade that amount to about €62 million ($79.6 million), the decision worried investors.

The market for credit derivatives was affected by last week’s downgrade in GM debt that finally equated it with the junk status. Given the massive size of the auto maker’s debt, the downgrade had a sizeable impact on the market.