Updated Dec 31, 2022 Credit Default Swaps (CDS) are financial instruments that provide protection against the risk of default on a loan or other debt instrument. That means they are a type of insurance that can be purchased by the lender or borrower of a loan. In the event of a default, the CDS pays out a predetermined amount to the lender or borrower. To illustrate this, imagine a bank that has lent USD 1 million to a company. The bank is worried that the company might default on the loan, so it purchases a CDS to protect itself. The CDS pays out USD 1 million in the event of a default. Thus, if the company does default, the bank will receive the full amount of the loan back from the CDS. On the other hand, if the company does not default, the bank will not receive any money from the CDS. However, the bank still has to pay a premium for the CDS. This premium is usually a percentage of the loan amount and is paid periodically. Credit Default Swaps are an important tool for managing risk in the financial markets. They allow lenders and borrowers to protect themselves against the risk of default on a loan. This reduces the risk of losses for both parties and makes it easier for them to enter into loan agreements. In addition, CDSs also provide liquidity to the markets. That means they make it easier for investors to buy and sell debt instruments. This increases the efficiency of the markets and makes it easier for investors to find buyers and sellers. Finally, CDSs also provide a way for investors to hedge their investments. That means they can use CDSs to offset potential losses from other investments.Definition of Credit Default Swaps (CDS)
Example
Why Credit Default Swaps Matter
Economics