Glossary · from the DESK dictionary
Credit Default Swap (CDS)
A derivative that, in exchange for an ongoing premium, protects against a borrower's default.
In plain words
Essentially 'insurance' against a bond issuer's default.
In more detail
A credit default swap transfers a reference obligor's default risk in exchange for a running premium. The protection buyer need not own the underlying claim, so outstanding volume can exceed an obligor's actual debt. For pricing, the spread is a direct measure of the market's assessed default probability, though mixed with a risk premium and a liquidity component. The decisive contractual point is the definition of a credit event: whether a restructuring, a payment delay or a contractual amendment triggers payment differs between documentation sets and has been the subject of several disputes. A case in which an obligor restructured formally without being in economic difficulty led to a fundamental revision of the standard contracts.
Example
1. The spread is 240 basis points at an assumed recovery rate of 40 percent. That implies an annual default probability of around 4 percent. 2. Protection outstanding totals 12 billion dollars against actual debt of 3 billion. A default triggers payments amounting to four times the underlying obligation.
What it means for traders
An important credit-risk-management tool and a closely watched market-stress indicator (CDS spreads).
Common pitfalls
A complex OTC derivative with counterparty risk, which played a central role in the 2008 financial crisis.
Related terms
CDX Index · Credit Derivative · Credit Event · Credit Linked Note (CLN) · Credit Spread · Default Swap Spread · Rating (Credit Rating)
From the DESK dictionary. For information only, not investment advice.
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DESK is a research tool and not investment advice. Page generated: 2026-10-12.