Finance Glossary
CDS (Credit Default Swap)
What is a CDS?
A CDS (Credit Default Swap) is a protection contract against the default of a issuer, traded between two parties (the buyer and the seller). CDS are traded over-the-counter between the buyer and the seller, meaning they are not listed on an exchange and are not subject to regulation.
CDS are complex derivative products used to protect against credit risk or to execute speculative strategies.
How does a CDS work?
The protection buyer of a CDS pays a premium (a percentage) to the seller, the amount of which depends on the asset they wish to cover. The seller, in turn, commits to compensating any potential losses incurred by the asset (or underlying). The buyer makes periodic payments until the CDS expires or the issuer defaults. This payment is determined by a Credit Spread.
The protection seller is not obligated to set aside funds to guarantee the unwinding of the transaction. They receive the premiums, and their capital increases without the need to secure funds.
In the event of default, the protection buyer obtains the right to sell a bond issued by the reference entity at its issuance value, for a predetermined amount (Cash Settlement), or the right to recover an equivalent debt (Physical Settlement).
