Credit Default Swap Short Form is CDS
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What is Credit Default Swap?
A credit default swap (CDS) is a financial derivative that provides insurance against the risk of a bond default. The buyer of the CDS makes periodic payments to the seller, and in return receives a payoff if the bond issuer defaults.
The CDS market is one of the largest and most active markets in the world, with a notional value of over $30 trillion. CDS contracts are used by a wide variety of market participants, including hedge funds, investment banks, and insurance companies.
The market for CDS contracts has come under scrutiny in recent years, as it was one of the key drivers of the financial crisis of 2008. In particular, the use of CDS contracts to hedge against mortgage-backed securities (MBS) and other collateralized debt obligations (CDOs) played a significant role in exacerbating the crisis.
What Are the Benefits of Credit Default Swaps?
Credit default swaps have a number of benefits, including:
- They provide a way to hedge against the risk of bond defaults.
- They are relatively easy to trade and liquid.
- They can be used to speculate on the creditworthiness of a bond issuer.
Despite these benefits, credit default swaps also have a number of risks, which should be considered before entering into a contract. These risks include:
- The risk of counterparty default.
- The risk that the reference entity will not actually default.
- The risk of regulatory change.
Before entering into a credit default swap contract, it is important to understand these risks and how they might impact the trade.