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You have not saved any content. None of the information on this page is directed at any investor or category of investors. Originally formed to provide banks with the means to transfer credit exposure, CDS has grown as an active portfolio management tool. The performance of CDS, like that of corporate bonds, is closely related to changes in credit spreads. This makes them an effective tool for hedging risk, and efficiently taking credit exposure. A CDS is the most highly utilized type of credit derivative.
In its most basic terms, a CDS is similar to an insurance contract, providing the buyer with protection against specific risks. Most often, investors buy credit default swaps for protection against a default, but these flexible instruments can be used in many ways to customize exposure to the credit market. CDS contracts can mitigate risks in bond investing by transferring a given risk from one party to another without transferring the underlying bond or other credit asset.
Prior to credit default swaps, there was no vehicle to transfer the risk of a default or other credit event, from one investor to another. CDS are designed to cover many risks, including: defaults, bankruptcies and credit rating downgrades. Credit default swaps provide a measure of protection against previously agreed upon credit events. The CDS market was originally formed to provide banks with the means to transfer credit exposure and free up regulatory capital.
Today, CDS have become the engine that drives the credit derivatives market. The performance of credit default swaps, like that of corporate bonds, is closely related to changes in credit spreads. This sensitivity makes them an effective tool for portfolio managers to hedge or gain exposure to credit. Credit default swaps also allow for arbitrage opportunities. Market volatility will likely be temporary, and long-run prospects for active investors remain robust.
The CDX index is actually a bond-like security itself made up of issuers of equal weights. The CDX index pays a coupon just like a bond, and in the event of a default or credit event from one of its issuers, the index closes and settled via auctions. The CDX index will then re-roll and re-create its index again. The credit default swaps market is really just a way for sophisticated investors to hedge away their risk, which is great.
And in fact, they might not even be right for sophisticated, deep-pocketed investors. Remember: More CDSes trade than actual junk bonds. As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
Market Insight, Financial Articles. Penny Stocks. They receive an ongoing premium, which means the CDS is insured. In simpler terms, a CDS is insurance toward the lender against borrower defaults aka non-payments. This agreement comes from the International Swaps and Derivatives Association. It's the go-to document that governs all kinds of credit derivatives, including credit-default swaps.
The most common way is to work through a lender, who already has the ins and can set you up with the paperwork. He did so against two types of assets in particular: investment-grade bonds and high-yield bonds. In order to mitigate this risk, we bought what are best described as insurance policies, called CDS on Wall Street. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.
These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand. How Credit Default Swaps Work. Hedging and Speculation. Market Risks. The Bottom Line. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.
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