Hi, do you know what is credit default swaps (CDS) and how does CDS work?
Big level II topic. The most basic CDS is an agreement between two parties in which the one party buys insurance from the other party to protect against a bond defaulting. If a credit event happens (which is broader than a default - for example a debt restructuring does it) then the person who bought the insurance gets something good - usually the right to sell the bond to the other party at par or similar. A google search will turn up infinite info on CDS.
In simplest terms - one counterparty pays the other a certain spread (in bps) for protection on a credit. They are OTC derivative contracts. Buying protection - short credit Selling protection - long credit Higher/wider spread - credit deteriorating Lower/tighter spread - credit improving
Thanks to broaden my horizons! I encountered this term while reading an article this morning yet can’t recall it from the Swaps content (Level I) I studied not long a ago… brief enuf to know the core concept.
In a year, I’m sure you will have this completely covered.
Its funny you mentioned that. I was reading an article in Bloomberg markets (a $5 magazine) and ran into this and how the market for these swaps is improving given all the defaults happening lately.
Improving? It’s getting huge. There was an interesting discussion about 6 months back about the consequences from the huge expansion of the market when the amount of CDS outstanding is much greater than the quantity of deliverable bonds fo some corporations. think not much, but some reasonable smart people felt differently.
During undergrad I did an internship on a CDO desk. The best way I found to understand CDS and similar instruments was through the diagram of parties and payments the traders would draw up. No can do on the forum, but a search of the net should yield something useful. Here is somethings I drummed up in about 45 seconds doing a google image search for “Credit Default Swaps” http://bionic.pmhclients.com/images/uploads/WindowsLiveWriterCreditdefaultswapsCDS_B58Aimage_8.png http://europe.pimco.com/NR/rdonlyres/B8875AC8-E251-45B0-A2D3-08FD9DC34C53/2278/CDStransaction.jpg http://giddy.org/defaultswap.jpg
the advantages of CDSs is that you can (1) manage credit risk and interest rate risk separately, (2) go short on underlying bonds, (3) take advantage of the more liquid CDS market, (4) create custom securities that may not be possible without CDSs