A credit default swap in which the buyer does not have an exposure to the underlying security. In a credit default swap, 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 of a debt security to the seller, who receives a series of fees for assuming this risk. In a naked swap, because the buyer does not hold the underlying security, the buyer is essentially betting the underlying security will default and then the buyer will receive payment. Because of the obvious moral hazard associated with this, some regulators took steps to limit or even abolish naked swaps in the wake of the late 2000s recession.
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