CDS (Credit Default Swaps) and Derivatives Primer
Jan 20, 2011 13:34:43 GMT -6
unlawflcombatnt likes this
Post by unlawflcombatnt on Jan 20, 2011 13:34:43 GMT -6
Below is the best primer I've found so far on Credit Default Swaps (CDS's). Also included right at the start is the simplest definition of Derivatives I've seen yet.
from the Atlanta Federal Reserve:
www.frbatlanta.org/filelegacydocs/erq407_mengle.pdf
Credit Derivatives: An Overview
by DAVID MENGLE
"A derivative is a bilateral agreement that shifts risk from one party to another; its value is derived from the value of an underlying price, rate, index, or financial instrument.
A credit derivative is an agreement designed explicitly to shift credit risk between the parties; its value is derived from the credit performance of one or more corporations, sovereign entities, or debt obligations.
Credit derivatives arose in response to demand by financial institutions, mainly banks, for a means of hedging and diversifying credit risks similar to those already used for interest rate and currency risks. But credit derivatives also have grown in response to demands for low-cost means of taking on credit exposure. The result has been that credit has gradually changed from an illiquid risk that was not considered suitable for trading to a risk that can be traded much the same as others....
How Credit Derivatives Work
The vast majority of credit derivatives take the form of the credit default swap (CDS), which is a contractual agreement to transfer the default risk of one or more reference entities from one party to the other....
One party, the protection buyer, pays a periodic fee to the other party, the protection seller, during the term of the CDS. If the reference entity defaults or declares bankruptcy or another credit event occurs, the protection seller is obligated to compensate the protection buyer for the loss by means of a specified settlement procedure.
The protection buyer is entitled to protection on a specified face value, referred to in this paper as the notional amount, of reference entity debt. The reference entity is not a party to the contract, and the buyer or seller need not obtain the reference entity’s consent to enter into a CDS...."
from the Atlanta Federal Reserve:
www.frbatlanta.org/filelegacydocs/erq407_mengle.pdf
Credit Derivatives: An Overview
by DAVID MENGLE
"A derivative is a bilateral agreement that shifts risk from one party to another; its value is derived from the value of an underlying price, rate, index, or financial instrument.
A credit derivative is an agreement designed explicitly to shift credit risk between the parties; its value is derived from the credit performance of one or more corporations, sovereign entities, or debt obligations.
Credit derivatives arose in response to demand by financial institutions, mainly banks, for a means of hedging and diversifying credit risks similar to those already used for interest rate and currency risks. But credit derivatives also have grown in response to demands for low-cost means of taking on credit exposure. The result has been that credit has gradually changed from an illiquid risk that was not considered suitable for trading to a risk that can be traded much the same as others....
How Credit Derivatives Work
The vast majority of credit derivatives take the form of the credit default swap (CDS), which is a contractual agreement to transfer the default risk of one or more reference entities from one party to the other....
One party, the protection buyer, pays a periodic fee to the other party, the protection seller, during the term of the CDS. If the reference entity defaults or declares bankruptcy or another credit event occurs, the protection seller is obligated to compensate the protection buyer for the loss by means of a specified settlement procedure.
The protection buyer is entitled to protection on a specified face value, referred to in this paper as the notional amount, of reference entity debt. The reference entity is not a party to the contract, and the buyer or seller need not obtain the reference entity’s consent to enter into a CDS...."