Credit default swap

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Credit default swap

A credit derivative contract between two parties where the buyer makes periodic payments (over the maturity period of the CDS) to the seller in exchange for a commitment to a payoff if a third party defaults. Generally used as insurance against default on a credit asset but can also be used for speculation.

Credit Default Swap

A swap in which the buyer makes a series of payments and, in exchange, receives a guarantee against default from the seller on a designated debt security. That is, the buyer transfers the risk that a debt security, such as a bond, will default to the seller, and the seller receives a series of fees for assuming this risk. In some ways, a credit default swap is like insurance, but there are significant differences. Prominently, the buyer of the credit default swap need not own the underlying debt security. Thus, the buyer may be speculating on the potential for default on the designated security. Likewise, the seller is not required to have the cash available to pay the buyer in case the designated security does default. This lack of regulation has raised concern, especially during the late 2000s credit crunch.
References in periodicals archive ?
Finally, it proposes a rule that solves this problem: Congress should allow the seller of a credit default swap to refuse to make a payout to a purchaser that does not negotiate a restructuring with the debt issuer underlying the swap.
Conceived in the aftermath of Drexel Burnham Lambert's (20) creation of collateralized debt obligations (21) in the late 1980s, (22) a credit default swap is a "promise[ ] to make a specified payment in the event a particular debt instrument experiences an event of default, such as a payment default or if the issuer files for bankruptcy protection.
This created a huge demand for credit default swaps as a kind of regulatory arbitrage.
It convinced itself, however, that only a sliver of the claims on those credit default swaps would come due.
Lockyer said that he is concerned that speculative trading of credit default swaps could boost borrowing costs.
Credit default swaps are tradable financial derivatives that function as a default insurance contract for corporate debt.

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