1.     If you are a market maker, e.g. an investment bank, how would you hedge the risks if you are holding CFD but intend to maintain market neutral?

If you have a position of CFD, let say long postion of 1m nominal of Apple stocks, it is almost equivalent of hoding same amount share except your total lost is capped if we suppose no extra margin is added. Let's say the initial margin is 10%, the total exposure will be 100k.
It would thus be possible to hedge with a put reverse barrier option with nominal of 1m and knock out at 10% down level which is cheaper.
It is also possible to hedge with futures, equity swaps

2.    Can you come up with a class of derivatives which share the same idea of the CFD?  Can you duplicate your proposed derivatives with vanilla options, futures, or swaps?
Vanilla:
Long put with current price K, 1m nominal and short a put with price K-10%K with 900k nominal

     Both up and down markets can be traded. When trading a contract for difference, you can place an order to trade regardless of whether the price of the product is bullish or bearish, and gain profits from selling (shorting) or buying opportunities. Many investors use contracts for differences as a way to hedge their existing portfolios in short-term volatile markets.
    Efficient use of capital. One of the most important advantages of contract for difference trading is the use of margin trading, so that you can take advantage of "leverage". This means that you don't need to invest the full amount of your position to trade, and since you don't have all your money to trade in one transaction, you can invest in multiple transactions at the same time. For example, if you buy 10000 telecom firm shares from a stockbroker, you need to pay for the full position; but if you buy the same stock spread contract through CMC markets, you only need to invest 5% of the full position value as the margin. If the price per share is $1.50, you only need to deposit a $750 position margin at CMC markets (5% of $15000), plus the applicable transaction commission. If you trade with a stockbroker on an equal basis, you will need to pay $15000 and related Commission and taxes
    CMC markets reminds investors that the use of margin trading means to enlarge the investment income, but please note that it will also enlarge the investment loss, and the amount of loss may exceed the initial investment. Investors can use a variety of tools on the platform to effectively manage the risk.

thanks