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What is a credit default swap?
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Quick answer
A credit default swap (CDS) is a financial contract that works like insurance against a borrower failing to repay a debt. One party pays regular fees, and in return the other promises to cover the loss if the debt defaults.
Key things to understand
- It's essentially insurance on a loan or bond defaulting.
- The buyer pays periodic premiums; the seller pays out if the borrower defaults.
- It lets investors hedge risk — or speculate on a borrower failing.
- You can buy one without owning the underlying debt, which adds risk.
- Their misuse amplified the 2008 financial crisis.
People also ask
How is a credit default swap like insurance?
You pay regular premiums and get a payout if a specific bad event — a borrower defaulting on its debt — happens. A key difference is that it's tradable and was lightly regulated.
Why were credit default swaps blamed for the 2008 crisis?
Huge volumes were written on risky mortgage debt, often by parties who couldn't cover the payouts. When defaults cascaded, the losses spread through the financial system.
Can anyone buy a credit default swap?
In practice they're traded between large financial institutions, not everyday investors — they're complex instruments far removed from ordinary banking.