Credit Default Swaps

Question 1

definition

Answer 1

• Contracts that transfer the credit risk of a fixed income product between parties.
• buyer of the CDS makes periodic payments to the seller in exchange for compensation if a credit event, default, bankruptcy, restructuring, failure to pay etc. occurs.

Question 2

what is cash settlement?

Answer 2

Cash Settlement: The protection seller pays the protection buyer the difference between the par value of the reference asset and its market value after the credit event.

Question 3

uses

Answer 3

1. Hedging: Hedge against potential losses from default on bonds or loans.
2. Speculation: Speculate on the credit quality of a reference entity. If they believe the credit quality will deteriorate, they may buy CDS, expecting to profit from an increase in the spread (premium).
3. Arbitrage: Investors might exploit price discrepancies between CDS and the underlying bond or other credit instruments to make arbitrage profits.