Credit Default Swaps (CDS)
Credit default swaps (CDS) can help investors assess the creditworthiness of a company.
What is a credit default swap?
A credit default swap gives institutional investors the opportunity to hedge the issuer or credit risk of an issuer/bond. A credit default swap is negotiated between two parties and relates to a reference debtor/bond.
A credit default swap gives institutional investors the opportunity to hedge the issuer or credit risk of an issuer/bond. A credit default swap is negotiated between two parties and relates to a reference debtor/bond.
How does a credit default swap work?
The protection buyer (purchaser of the CDS) pays a one-off or regular (insurance) premium to the protection seller (seller of the CDS). In the event that a credit event occurs and the reference debtor is unable to repay their debt (due to insolvency, illiquidity, suspension or default of payment, debt restructuring, etc.) the protection buyer receives a compensation payment from the protection seller.
The protection buyer (purchaser of the CDS) pays a one-off or regular (insurance) premium to the protection seller (seller of the CDS). In the event that a credit event occurs and the reference debtor is unable to repay their debt (due to insolvency, illiquidity, suspension or default of payment, debt restructuring, etc.) the protection buyer receives a compensation payment from the protection seller.
Unlike ratings, which can only reflect changes in creditworthiness with (at times) considerable delays, the premiums on the CDS market generally react promptly and can therefore provide faster and more accurate information about a company’s creditworthiness.
How should the price of a credit default swap be understood?
The premium is quoted in basis points (1/100 of a percentage point) and represents the price currently payable by the protection buyer to an insurer for a CDS.
The premium is quoted in basis points (1/100 of a percentage point) and represents the price currently payable by the protection buyer to an insurer for a CDS.
As a general rule, a relatively low CDS price means a low risk premium – and can be interpreted as a good credit rating (i.e., high creditworthiness).
For example: A CDS on company ABC is traded at 50 basis points. So, if you hold ABC bonds with a nominal value of 1,000,000 euros and want to hedge them against a default by ABC, you have to pay 0.005 x 1,000,000 euros = 5,000 euros to the protection seller.
The information provided here relates to credit default swaps with a term of five years, based on the issuers’ corporate bonds.
Source: CMA, part of Intercontinental Exchange, Inc. © 2025, Credit Market Analysis Limited. All rights reserved.
Source: CMA, part of Intercontinental Exchange, Inc. © 2025, Credit Market Analysis Limited. All rights reserved.