![]() The reference entity is not a party to the contract. ![]() 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.Ī CDS is linked to a "reference entity" or "reference obligor", usually a corporation or government. A CDS can be unsecured (without collateral) and be at higher risk for a default. Some claim that derivatives such as CDS are potentially dangerous in that they combine priority in bankruptcy with a lack of transparency. In addition to corporations and governments, the reference entity can include a special purpose vehicle issuing asset-backed securities. In addition to the basic, single-name swaps, there are basket default swaps (BDSs), index CDSs, funded CDSs (also called credit-linked notes), as well as loan-only credit default swaps (LCDS). Most CDSs are documented using standard forms drafted by the International Swaps and Derivatives Association (ISDA), although there are many variants. ĬDS data can be used by financial professionals, regulators, and the media to monitor how the market views credit risk of any entity on which a CDS is available, which can be compared to that provided by the Credit Rating Agencies. There is "$8 trillion notional value outstanding" as of June 2018. In March 2010, the Depository Trust & Clearing Corporation (see Sources of Market Data) announced it would give regulators greater access to its credit default swaps database. During the 2007–2010 financial crisis the lack of transparency in this large market became a concern to regulators as it could pose a systemic risk. CDSs are not traded on an exchange and there is no required reporting of transactions to a government agency. ![]() By the end of 2007, the outstanding CDS amount was $62.2 trillion, falling to $26.3 trillion by mid-year 2010 and reportedly $25.5 trillion in early 2012. ![]() Ĭredit default swaps in their current form have existed since the early 1990s and increased in use in the early 2000s. The payment received is often substantially less than the face value of the loan. If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction. 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). 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. 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. ![]() That is, the seller of the CDS insures the buyer against some reference asset defaulting. If the reference bond defaults, the protection seller pays par value of the bond to the buyer, and the buyer transfers ownership of the bond to the sellerĪ 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. ![]()
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