Investing and Financial Markets

What is a credit default swap?


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2009-05-16 15:07:38
2009-05-16 15:07:38

I would recommend reading the article "The Price of Greed" in the Sept 29 issue of Time magazine. CDS's are derivatives, sold by AIG, designed to protect investors from failures of other companies. Time calls them "pixie-dust" securities that supposedly offer insurance against a company defaulting on its obligations. They are collaterized, which is where AIG got into trouble when their credit rating was downgraded. The required additional collaterial was nowhere to be found. A CDS is essentially an insurance policy for credit derivatives. It's not technically insurance for quite a few reasons, chief among them being that, as derivatives, the sellers aren't regulated nor are they required to maintain reserves enabling them to pay off the buyers if the underlying securities default, and the buyer of a CDS doesn't need to own the derivative he's insuring. These are the "naked CDS." I have written extensively on the evil that is the naked CDS, usually comparing it to naked fire insurance. If they sold that product, very little would prevent the naked fire insurance holder from going over to his neighbor's house and setting it on fire so he could collect. AIG was the leader in the naked CDS and a very large player in clothed CDS, In ten years, when the dust has settled, we'll all look back and think, "who thought THIS was a good idea?" Until then the naked CDS stands as prima facie evidence that deregulating the derivatives market was a really stupid idea.

A credit default swap (CDS) is a credit derivative contract between two counter parties, whereby the buyer makes periodic payments to the seller in exchange for the right to a payoff if there is a default or credit event in respect of a third party or reference entity.

A credit default swap (CDS) is a swap contract in which the buyer of the CDS makes a series of payments to the seller and, in exchange, receives a payoff if a credit instrument (typically a bond or loan) goes into default or on the occurrence of a specified credit event (for example bankruptcy). Credit Default Swaps can be bought by any investor; it is not necessary for the buyer to own the underlying credit instrument.

A CDS is like a Health insurance policy that we may take to cover up for the cash requirements if we get any health problems. We pay a premium to the insurance company and if we get any health problems, the insurer would pay for the medical treatment. Here are the differences between credit default swaps and "traditional" insurance, according to Wikipedia: * the seller need not be a regulated entity; * the seller is not required to maintain any reserves to pay off buyers, although major CDS dealers are subject to bank capital requirements; * insurers manage risk primarily by setting loss reserves based on the Law of large numbers, while dealers in CDS manage risk primarily by means of offsetting CDS (hedging) with other dealers and transactions in underlying bond markets; * in the United States CDS contracts are generally subject to mark to market accounting, introducing income statement and balance sheet volatility that would not be present in an insurance contract; * Hedge Accounting may not be available under US GAAP unless the requirements of FAS 133 are met; in practice this rarely happens; * The buyer of a CDS does not need to own the underlying security or other form of credit exposure; in fact the buyer does not even have to suffer a loss from the default event.[2][3][4] By contrast, to purchase insurance the insured is generally expected to have an insurable interest such as owning a debt. The last one is the most important here. Think of fire insurance. They don't allow people to purchase fire insurance on other people's buildings for the obvious reason: people would insure the worst firetraps in town, then go around burning them down to collect the insurance settlements. OTOH, you can buy CDS contracts on derivatives you don't own and never will--essentially betting that the underlying derivative is going to fail. Here's an example: You are the CEO of the biggest factory in the state, and you're getting ready to move your operations to Vietnam--which is going to put a few thousand people out of work. You could use your contacts in business to find out where your employees' mortgages are tranched (read up on structured financing), and buy naked CDS on those tranches. If you're the only one in town that pays decently, a lot of your employees are going to lose their homes, and you'll be in fat city when it happens. Right now you should be thinking, my but that would be a vicious thing to do. Yes it would, but so would closing your factory because you can get kitchen utensils made in China for two percent less than you're making them in the US, and that happens all the damn time.


Related Questions

The agreement for a credit default swap is a document that states the buyer will reimburse the holder in the event of a loan default or other credit event. This is essentially insurance against someone not paying you what you are owed.

There is no "minimum amount" required for a party to enter into a credit default swap. The market for CDS products varies and terms are set by both parties agreeing to enter into the transaction.

Credit default swaps were invented with collateralised debt obligations in 1995 by Ms. Blythe Masters, a 34-year Cambridge graduate who was then the head of JP Morgan's Global Credit Derivatives group.

Sergio Mayordomo has written: 'Are all credit default swap databases equal?'

I think what you are referring to is basically a credit default swap. This is a kind of insurance that the lender of the loan or the mortgage can purchase in order to ensure that the re-payment on the loan will be made in the event that the borrower defaults on the payment. This protects the back and spreads the risk.

Everything has to be entered. You can write down the number with a little notation to show that a swap has been made.

"Most of the time, they take two people's bad credit and subtract both debts by the lower number. They can, however, make you sign a contract. SO WATCH out and read the contracts."

The acronym CDS is a credit default swap. A financial term for a derivative contract whereby one party buys protection against the default of a reference credit and the other counterpary sells the protection, i.e. agrees to receive periodic payments in exchange for providing insurance against the default of an obligor.The acronym CDs is the plural form for compact disk and certificate of deposit.

why credit provider decline if donot have default, overdue,or court judgements account in credit file?

Yes, if you default on any loan it will affect your credit rating negatively.

A naked CDS is the purchase of CDS's without an investment in the underlying asset. Essentially buying insurance without the asset. Usually linked with speculation in the creditworthiness of the company. Speculators trade the likelihood a company will default on its payments.

Both Interest rate swap and Credit default swap carries a different kinds of inherent risks. In IRS two parties involved together to swap the fixed rate v/s floating rate of swaps or vice versa whereas in CDS it is more like Default insurance where the purchase of CDS pays a regular premium to the seller of the instrument in return for a guarantee of payment in event of fixed assets turns sour.

If you have a bad credit report from a loan in default a lender wouldn't want your guaranty that the primary borrower's loan will be paid by you if they default.If you have a bad credit report from a loan in default a lender wouldn't want your guaranty that the primary borrower's loan will be paid by you if they default.If you have a bad credit report from a loan in default a lender wouldn't want your guaranty that the primary borrower's loan will be paid by you if they default.If you have a bad credit report from a loan in default a lender wouldn't want your guaranty that the primary borrower's loan will be paid by you if they default.

All revenues has credit balances as default balance like wise rent revenue also has credit balance as default balance instead of debit balance because all expenses has debit as default balance.

First, you need to enable the shoulder swap in the options. The default has shoulder swap disabled (which is ridiculous). Then, you do it the same way you did in Uncharted 2: by pressing R3.

I believe you are asking about credit default swap. Say I have a bank, and I have a certain risk or exposure of losing money on bad home loans, I may look for someone I can pay, to guarantee the repayment. I'm the buyer of "credit protection" and the seller now has assume the risk of the bad loans. Now, the insurance analogy is quite clear. It may appear that since I bought credit protection, the loans I hold are worth more. This works so long as the seller of the swap has the cash to make good in case of non-payment (default). The swap seller has to consider the percent of loans he might have to pay out on. He sets the swap price for the "credit protection" accordingly. But, here's the rub- he may have a lot of statistics on the percent of bad loans, and the number will be very low, say 0.5%, but that's in the housing boom times. In good times, home owners without the income to pay simply re-finance with the added equity in their homes. They tap into their credit cards for quick cash. Obviously, in bad times, the swap seller runs short of money to guarantee the loans. The buyer of the swap is now in the hole too. His credit rating drops as the swaps no longer offer same protection. There is also the concept from statistics that if there are many loans involved, then the risk should be more accurately factored into the price, as averages tend toward the population mean as the sample size increases. Unfortunately, the population mean (strictly just a concept) in this situation is not stationary (fixed in time). As one economist put it, you can't make a bad loan into a good loan with insurance or swaps. The swap moved the credit risk exposure from one institution to another. In good times, it was win-win for buyer and seller. In bad times, we have lose-lose. While the swaps have similarity to insurance, it's not like fire or theft insurance as all the fraction of houses on fire or being broken into does not suddenly rise. This is referred to as systemic risk in the credit default swaps. See more: Also, Wikipedia has a good description of credit default swaps. It's a complicated area and I would appreciate anyone with experience in this area who can add to this. Some extra points to add on to this: 1. With CDS the banks expected the risk of loan defaults to be transferred to the Insurance Provider. When a default would occur they would go to the Insurance provider and get the loan default amount 2. The Insurance provider did not expect a whole group of population to surrender their homes and close their mortgage loans. When the default rate on the loans in the bank increases, the collateral or the security amount the Insurer has to place as amount for credit protection increases. When the defaults increased many fold the swap providers were unable to increase the credit protection amount. This is why AIG went broke and the US government had to pitch in to help it...

yes if they default it will hurt your credit yes if they default it will hurt your credit

All expenses has debit balance as normal default balance while all income has credit balance as normal default balance.

No all revenues has credit balance as default balance while all expenses has debit balance as default normal balance.

Actually, the default will stay on your credit indefinately until you get out of default. Student loan default on Federally Guaranteed student loans has no statute of limitation. If you consolidate your defaulted student loans, they will show up as Paid In Full on your credit report. You can get help with the consolidation of your student loans through Any default is going to stick around for about 7 years.

"If you wanted to do some credit default swaps, there are definitely many places to do that. There are areas such as the internet. There are also places where you can do it, like the bank."

Sales is a revenue account and all revenues has credit balance as default balance so sales also has credit as default balance while cash or accounts receivable will be debited against it.

A company can seize assets doe to credit card default if they obtain a judgment through the court. You will be notified of the court date.

A home equity line of credit is a mortgage. If you default the lender will foreclose and take possession of the property by the foreclosure procedure used in your state.

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