Credit default swap (CDS)
Principles of Finance glossary · Valuation of Bonds & Stocks
Definition
An instrument in which the protection buyer pays periodic premiums to the protection seller in exchange for compensation if a credit event occurs.
Credit default swap (CDS) in plain English
A credit default swap is basically an insurance policy on a loan or bond. The buyer makes small regular payments to the seller, and in return the seller promises to pay up if the borrower behind that bond fails — for example, goes bankrupt or misses payments (a "credit event"). It works just like paying a yearly premium to insure your car: cheap payments now protect you from a big loss later. Investors use these both to protect bonds they own and to bet on whether a company will run into trouble.
Also called: CDS
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