What is Credit Default Swap?

Credit Default Swaps are a type of derivative contract that allows one investor to swap or transfer his credit risk to another.

If a lender is concerned that a borrower may default on a loan, for example, he might offset or transfer the risk.

To hedge against default, the lender purchases a credit default swap (CDS) from another investor who offers to compensate the lender if the borrower defaults. The majority of CDS contracts are maintained by a recurring premium payment, similar to how an insurance policy’s regular payments are paid.

This risk can be transferred to a company, country, or any other entity.

During the European sovereign debt crisis, credit default swaps were widely used.

Greece’s government bonds had a 94 percent default chance in September 2011. CDS were widely employed by hedge funds to bet on the prospect of the possibility that the country would default.

What is Credit Default Swap?
What is Credit Default Swap?

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