Credit Default Swaps (CDS)

Extracted Attributes

• Risk

  Systemic risk

• Type

  Financial derivative contract

• Purpose

  Transfers credit risk; provides insurance against debt default

• Mechanism

  Buyer makes periodic payments to seller; seller pays lump sum to buyer upon credit event

• Key Feature

  Can be purchased without holding the underlying loan ('naked' CDS)

• Payout Mechanism

  Compensation typically face value, but can be less if credit event auction is held

• Underlying Instruments

  Bonds, securitized debt, fixed-income products

Timeline

• Played a large role in the financial crisis, leading to bankruptcies of large banks that traded in CDSs due to widespread defaults of underlying credit instruments. (Source: web_search_results)

  2008

• Identified as a potentially interesting, though risky, trade amidst forecasts of a possible banking crisis. (Source: related_documents)

  2025

Credit default swap

A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default (by the debtor) or other credit event. That is, the seller of the CDS insures the buyer against some reference asset defaulting. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, may expect to receive a payoff if the asset defaults. In the event of default, the buyer of the credit default swap receives compensation (usually the face value of the loan), and the seller of the CDS takes possession of the defaulted loan or its market value in cash. However, anyone can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in the loan (these are called "naked" CDSs). If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction. The payment received is often substantially less than the face value of the loan.

Web Search Results

• credit default swap | Wex | US Law | LII / Legal Information Institute

  Cornell University insignia # credit default swap A credit default swap (CDS) is a type of derivative contract in which two parties exchange the risk that some credit instrument will go into default. The buyer of a CDS agrees to make periodic payments to the seller. In exchange, the seller agrees to pay a lump sum to the buyer if the underlying credit instrument enters default. [...] While Credit Default Swaps can be used to mitigate risk, they also carry risk in and of themselves. A CDS protects an investor from a third-party default but opens that investor up to the risk that the CDS seller itself will default. In this scenario, a party would lose not only the income from the underlying credit instrument which went into default, but they would also lose the money they paid in premiums to the CDS seller. [...] Credit default swaps played a large role in the financial crisis of 2008 for many of the same reasons described above. Large banks which traded in CDS’s were forced to declare bankruptcy when a large number of the underlying credit instruments defaulted at once, sending shockwaves throughout the United States economy.

• Credit Default Swap: What It Is and How It Works - Investopedia

  A credit default swap (CDS) is a financial derivative that allows an investor to swap or offset their credit risk with that of another investor. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse them if the borrower defaults. [...] ## How Credit Default Swaps (CDSs) Work A credit default swap is a derivative contract that transfers the credit exposure of fixed-income products. It may involve bonds or forms of securitized debt—derivatives of loans sold to investors. For example, suppose a company sells a bond with a $100 face value and a 10-year maturity to an investor. The company might agree to pay back the $100 at the end of the 10-year period with regular interest payments throughout the bond’s life. [...] CDSs played a key role in the credit crisis that eventually led to the Great Recession. Credit default swaps were issued by American International Group (AIG), Bear Stearns, and Lehman Brothers to investors to protect against losses if the mortgages that were securitized into mortgage-backed securities (MBS) defaulted.

• [PDF] Credit Default Swap –Pricing Theory, Real Data Analysis and ...

  in an upper-division undergraduate Finance class or an MBA class. 1 I. Introduction A credit default swap (CDS) is a derivatives instrument that provides insurance against the risk of a default by a particular company. This contract generally includes three parties: first the issuer of the debt security, second the buyer of the debt security, and then the third party, which is usually an insurance company or a large bank. The third party will sell a CDS to the buyer of the debt security. The [...] CDS offers insurance to the buyer of the debt security in case the issuer is no longer able to pay. In the case of a default, the seller of the CDS is obligated to buy the debt security for its face value from the buyer of the CDS. An example of a CDS will help illustrate how the cash flows work. In this example, Company X is issuing a 10-year, 8% bond with a $10 million par value. Company Y has excess liquid funds, which are earning no interest at this time, and so they decide to buy Company [...] written on bonds. If the reference entity (bond issuer) defaults at time t (t<=T, where T is the maturity date), the CDS buyer will get a payment from the seller. This payment is referred to as the payoff from the CDS. The payoff from a CDS is usually different from the amount of the debt because the recovery rate is non- zero in most cases. When a bond defaults, bondholders will typically get part of their investment back from the liquidation of the issuer’s assets. According to Moody’s

• Credit Default Swap - Defintion, How it Works, Risk

  # Credit Default Swap Insurance against non-payment ## What is a Credit Default Swap (CDS)? A credit default swap (CDS) is a type of credit derivative that provides the buyer with protection against default and other risks. The buyer of a CDS makes periodic payments to the seller until the credit maturity date. In the agreement, the seller commits that, if the debt issuer defaults, the seller will pay the buyer all premiums and interest that would’ve been paid up to the date of maturity. [...] credit default swap (CDS) credit default swap (CDS) Through a credit swap, a buyer can take risk control measures by shifting the risk to an insurance company in exchange for periodic payments. Just like an insurance policy, a CDS allows purchasers to buy protection against an unlikely event that may affect the investment. [...] One of the risks of a credit default swap is that the buyer may default on the contract, thereby denying the seller the expected revenue. The seller transfers the CDS to another party as a form of protection against risk, but it may lead to default. Where the original buyer drops out of the agreement, the seller may be forced to sell a new CDS to a third party to recoup the initial investment. However, the new CDS may sell at a lower price than the original CDS, leading to a loss.

• Credit default swap - Wikipedia

  However, if the associated credit instrument suffered a credit event at t 5, then the seller pays the buyer for the loss, and the buyer would cease paying premiums to the seller. A "credit default swap" (CDS) is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults "Default (finance)") or experiences a similar credit event.( [...] Credit default swaps allow investors to speculate on changes in CDS spreads of single names or of market indices such as the North American CDX index or the European iTraxx index. An investor might believe that an entity's CDS spreads are too high or too low, relative to the entity's bond yields, and attempt to profit from that view by entering into a trade, known as a basis trade, that combines a CDS with a cash bond and an interest rate swap._[citation needed_] [...] Credit default swaps are often used to manage the risk of default that arises from holding debt. A bank, for example, may hedge its risk that a borrower may default on a loan by entering into a CDS contract as the buyer of protection. If the loan goes into default, the proceeds from the CDS contract cancel out the losses on the underlying debt.(