CREDIT

DEFAULT
SWAPS
Exploring Mechanics,
Benefits, and Risks of CDS
What is a Credit
Default Swap?
A Credit Default Swap (CDS) is a
financial contract that acts like an
insurance against the risk of a
borrower not being able to repay
their debt.

It involves one party paying a premium

to another party in exchange for
protection in case of a credit event,
like a default.
 Meet the parties
involved:
Protection Buyer:
Pays premium and seeks
protection against credit risk.

Protection Seller:
Assumes the credit risk and
receives the premium.
How does CDS work?
Ever loaned money to a friend and
worried he might not pay you back?

Imagine this:
1. You lend money to your friend.
2. You're concerned he may not be
able to repay.
3. So, you ask someone else to step in
as a backup.
4. That person promises to pay you if
your friend can't.

🌟 That's how a CDS works!

Notional Amount
Imagine:
1. You and your friend decide to make
bets together.
2. You agree on a notional amount, let's
say $100.
3. Each bet's outcome determines the
payment obligations between you two.

💰 The higher the notional amount, let's

say $500, the bigger the potential payout
if you win the bets!

🎯 It's like setting the total value at stake

in the game!
 Credit Event
Situations like - when someone
can't pay back their debts, goes
bankrupt, or needs to restructure
their finances.

If one of these credit events

happens, the protection seller will
step in and give money to the
buyer to cover the losses they
might face.

It's like a safety net to help protect

against financial troubles.
Risks in CDS
1. Counterparty Risk:
The person who promised to protect
you might not be able to follow
through.

2. Market Volatility:
CDS prices can swing widely due to
market changes, making them hard
to predict.

3. Lack of Transparency:
Getting clear information about CDS
trades can be challenging.
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