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If the reference bond performs without default, the protection buyer pays quarterly payments to the seller until maturity
If the reference bond defaults, the protection seller pays par value of the bond to the buyer, and the buyer transfers ownership of the bond to the seller

A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer (usually the creditor of the reference loan) in the event of a loan default (by the debtor) or other credit event. This is to say that the seller of the CDS insures the buyer against some reference loan defaulting. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults. It was invented by Blythe Masters from JP Morgan in 1994.

In the event of default the buyer of the CDS receives compensation (usually the face value of the loan), and the seller of the CDS takes possession of the defaulted loan.<ref name="LBO CDS" /> However, anyone can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in the loan (these are called "naked" CDSs). If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction; the payment received is usually substantially less than the face value of the loan.<ref>{{#invoke:citation/CS1|citation |CitationClass=web }}</ref>

Credit default swaps have existed since 1994, and increased in use after 2003. By the end of 2007, the outstanding CDS amount was $62.2 trillion,<ref name='ISDA Annual Chart'>{{#invoke:citation/CS1|citation |CitationClass=web }}</ref> falling to $26.3 trillion by mid-year 2010<ref name="test">ISDA 2010 MID-YEAR MARKET SURVEY. Latest available a/o 2012-03-01.</ref> and reportedly $25.5<ref>{{#invoke:citation/CS1|citation |CitationClass=web }}</ref> trillion in early 2012. CDSs are not traded on an exchange and there is no required reporting of transactions to a government agency.<ref name='IMF254'>{{#invoke:Citation/CS1|citation |CitationClass=journal }}</ref> During the 2007-2010 financial crisis the lack of transparency in this large market became a concern to regulators as it could pose a systemic risk.<ref name='Deutsche Bank Report' /><ref name="SimkovicSecret">Simkovic, Michael, Secret Liens and the Financial Crisis of 2008.</ref><ref name='Sirri Testimony' /><ref name='Partnoy Article'>{{#invoke:Citation/CS1|citation |CitationClass=journal }}</ref> In March 2010, the Depository Trust & Clearing Corporation (see Sources of Market Data) announced it would give regulators greater access to its credit default swaps database.<ref>{{#invoke:citation/CS1|citation |CitationClass=web }}</ref>

CDS data can be used by financial professionals, regulators, and the media to monitor how the market views credit risk of any entity on which a CDS is available, which can be compared to that provided by the Credit Rating Agencies. U.S. Courts may soon be following suit.<ref name="LBO CDS">Simkovic, Michael, "Leveraged Buyout Bankruptcies, the Problem of Hindsight Bias, and the Credit Default Swap Solution", Columbia Business Law Review (Vol. 2011, No. 1, pp. 118), 2011.</ref>

Most CDSs are documented using standard forms drafted by the International Swaps and Derivatives Association (ISDA), although there are many variants.<ref name="Deutsche Bank Report"/> In addition to the basic, single-name swaps, there are basket default swaps (BDSs), index CDSs, funded CDSs (also called credit-linked notes), as well as loan-only credit default swaps (LCDS). In addition to corporations and governments, the reference entity can include a special purpose vehicle issuing asset-backed securities.<ref name='Mengle Overview'>{{#invoke:Citation/CS1|citation |CitationClass=journal }}</ref>

Some claim that derivatives such as CDS are potentially dangerous in that they combine priority in bankruptcy with a lack of transparency.<ref name="SimkovicSecret">Simkovic, Michael, "Secret Liens and the Financial Crisis of 2008".</ref> A CDS can be unsecured (without collateral) and be at higher risk for a default.


Credit default swap sections
Intro  Description  Uses  History  Terms of a typical CDS contract  Credit default swap and sovereign debt crisis  Settlement  Pricing and valuation  Criticisms  Tax and accounting issues  LCDS  See also  Notes  References  External links  

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{{ safesubst:#invoke:Unsubst||$N=Use mdy dates |date=__DATE__ |$B= }}

If the reference bond performs without default, the protection buyer pays quarterly payments to the seller until maturity
If the reference bond defaults, the protection seller pays par value of the bond to the buyer, and the buyer transfers ownership of the bond to the seller

A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer (usually the creditor of the reference loan) in the event of a loan default (by the debtor) or other credit event. This is to say that the seller of the CDS insures the buyer against some reference loan defaulting. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults. It was invented by Blythe Masters from JP Morgan in 1994.

In the event of default the buyer of the CDS receives compensation (usually the face value of the loan), and the seller of the CDS takes possession of the defaulted loan.<ref name="LBO CDS" /> However, anyone can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in the loan (these are called "naked" CDSs). If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction; the payment received is usually substantially less than the face value of the loan.<ref>{{#invoke:citation/CS1|citation |CitationClass=web }}</ref>

Credit default swaps have existed since 1994, and increased in use after 2003. By the end of 2007, the outstanding CDS amount was $62.2 trillion,<ref name='ISDA Annual Chart'>{{#invoke:citation/CS1|citation |CitationClass=web }}</ref> falling to $26.3 trillion by mid-year 2010<ref name="test">ISDA 2010 MID-YEAR MARKET SURVEY. Latest available a/o 2012-03-01.</ref> and reportedly $25.5<ref>{{#invoke:citation/CS1|citation |CitationClass=web }}</ref> trillion in early 2012. CDSs are not traded on an exchange and there is no required reporting of transactions to a government agency.<ref name='IMF254'>{{#invoke:Citation/CS1|citation |CitationClass=journal }}</ref> During the 2007-2010 financial crisis the lack of transparency in this large market became a concern to regulators as it could pose a systemic risk.<ref name='Deutsche Bank Report' /><ref name="SimkovicSecret">Simkovic, Michael, Secret Liens and the Financial Crisis of 2008.</ref><ref name='Sirri Testimony' /><ref name='Partnoy Article'>{{#invoke:Citation/CS1|citation |CitationClass=journal }}</ref> In March 2010, the Depository Trust & Clearing Corporation (see Sources of Market Data) announced it would give regulators greater access to its credit default swaps database.<ref>{{#invoke:citation/CS1|citation |CitationClass=web }}</ref>

CDS data can be used by financial professionals, regulators, and the media to monitor how the market views credit risk of any entity on which a CDS is available, which can be compared to that provided by the Credit Rating Agencies. U.S. Courts may soon be following suit.<ref name="LBO CDS">Simkovic, Michael, "Leveraged Buyout Bankruptcies, the Problem of Hindsight Bias, and the Credit Default Swap Solution", Columbia Business Law Review (Vol. 2011, No. 1, pp. 118), 2011.</ref>

Most CDSs are documented using standard forms drafted by the International Swaps and Derivatives Association (ISDA), although there are many variants.<ref name="Deutsche Bank Report"/> In addition to the basic, single-name swaps, there are basket default swaps (BDSs), index CDSs, funded CDSs (also called credit-linked notes), as well as loan-only credit default swaps (LCDS). In addition to corporations and governments, the reference entity can include a special purpose vehicle issuing asset-backed securities.<ref name='Mengle Overview'>{{#invoke:Citation/CS1|citation |CitationClass=journal }}</ref>

Some claim that derivatives such as CDS are potentially dangerous in that they combine priority in bankruptcy with a lack of transparency.<ref name="SimkovicSecret">Simkovic, Michael, "Secret Liens and the Financial Crisis of 2008".</ref> A CDS can be unsecured (without collateral) and be at higher risk for a default.


Credit default swap sections
Intro  Description  Uses  History  Terms of a typical CDS contract  Credit default swap and sovereign debt crisis  Settlement  Pricing and valuation  Criticisms  Tax and accounting issues  LCDS  See also  Notes  References  External links  

PREVIOUS: IntroNEXT: Description
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