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Glossary

Credit Default Swap (CDS)

Category — Derivatives
A Credit Default Swap (CDS) is a financial derivative in which the credit protection seller agrees to pay the buyer a specified amount in the contract (usually the nominal less the recovered debt value) in case a certain credit event occurs. In return, the CDS purchaser makes one-time or recurring payments corresponding to the refund amount. The list of credit events in which the CDS payment occurs is determined by the contractual parties. This can be non-payment of the principal amount of the debt, the occurrence of a technical default, refusal to pay coupon payments ordebt restructuring

The cost of the CDS premium directly depends on the market assessment of the issuer’s reliability. CDS quotes react more quickly to the deterioration of the borrower’s financial condition than rating agencies. The higher the cost of default swaps, the higher the risk.

The history of CDS: Credit default swaps are believed to have been invented by an employee of JP Morgan Blythe Masters in 1994. Despite their relatively recent creation, CDS have quickly become a popular financial instrument. According to the International Swaps and Derivatives Association, CDS trading volumes have doubled annually from 2003 to 2007. By the beginning of 2008, the CDS market volume was 62.2 trillion US dollars, which exceeded the size of world GDP.

Initially, CDS were conceived as a credit risk hedging tool, but they quickly became popular among speculators. Thanks to their active distribution, banks issued loans of poor quality without strongly assessing the creditworthiness of borrowers. This led to the creation of a bubble in the US mortgage market, which in 2007 became one of the main causes of the financial and then global economic crisis.

Information on the cost of CDS for the sovereign debt of various countries can be found on the Cbonds website at the Indices section - Derivatives Market - Credit Default Swaps (CDS). For example: CDS 10Y Belarus

On the basis of CDS quotes, the default probability of a particular issuer is calculated for the period corresponding to the CDS period. Information on the default probability (based on CDS) can be found in the same place, in the section "Indices" - "Derivatives market" - " Default Probability (based on CDS)".
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