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What is a Credit Default Swap and Why Should I Care?

Credit Default Swaps – A Primer

A credit default swap is a type of credit derivative. Credit derivatives “derive” their value from an underlying credit instrument; generally the bonds of sovereign nations or the bonds of a corporate entity. In recent years, credit derivatives have been created that are based obligations rather than entities; one common reference obligation are asset backed securities based on home equity loans.

A credit default swap is a contract that allows one to take or reduce credit exposure. The contract is between the two parties and does not directly involve the underlying reference entity. A credit default swap is essentially an insurance policy where one entity pays a premium to a second entity to take on the risk of a loss.

Let’s look at a fictitious example.

Answer to Yesterday’s Poll Question…

What was the top marginal federal tax rate for individuals in 1955?

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