Credit Default Swaps: YF Explains

The term ‘credit default swap’ (also known as CDS) is back in the news on the heels of the Silicon Valley Bank (SIVB) fallout and the crisis at Credit Suisse (CS).

Credit default swaps have historically played a major role in how financial institutions attempt to mitigate risk. A CDS is an insurance contract on a bond or a loan in which one party or entity purchases protection from another to protect against the risk of default.

Yahoo Finance’s Jared Blikre breaks it all down in layman's terms.

Video Transcript

JARED BLIKRE: Credit default swaps, or CDS, back in the news, evoking memories of 2008 and the global financial crisis, as well as "The Big Short" movie, but we're talking about today.

A CDS contract amounts to an insurance contract on a bond or a loan to protect against the risk of default. That's the credit and the default part, but we want to talk about the swap part as well. And that refers to the exchange of payments or cash flows between the buyer and the seller.

Now when the contract is initiated, the buyer will make an upfront payment plus maybe quarterly or annual installments and the seller is only responsible for payment in the event of default. That is a credit event. It could be a missed payment on the bond or it could be the company filing for bankruptcy.

Who uses CDS? Probably not you and me. But institutional, large institutional bond managers with millions of billions of dollars invested, they, of course, want to hedge their risk in the market. And for you and me, quite helpful to know what Wall Street is watching and what keeps them up at night.