Glossary

A Credit Default Swap (CDS) is a financial derivative instrument that allows investors to hedge or speculate on the credit risk of an underlying bond or loan.

It works as a contract between two parties: the buyer, who wants protection against a credit event (eg. default), and the seller, who agrees to pay out a sum of money if such an event occurs. In exchange, the buyer pays a periodic premium to the seller. 📝💸

For example, an investor holding a corporate bond might purchase a CDS to protect against the risk of the issuer defaulting. If the issuer does default, the seller of the CDS will compensate the buyer, thus mitigating their losses.

Fun fact: The 2008 financial crisis brought CDS to the forefront, as these instruments played a significant role in amplifying the effects of the housing market crash. The collapse of the CDS market highlighted the need for better regulation and transparency in the derivatives market. 🏠📉