CDS – Finance for everyone

CDS (credit default swap) is a type of insurance by which financial institutions protect themselves against the risk of loan default by paying an insurance premium.

Contrary to what their name suggests, these credit derivatives they are options rather than swaps.

Let’s take the example of a company (called the “reference entity”) that has issued €x million of debt over five years. The banking institution that granted the loan wants to protect itself.

Annual premiums apply to protection vendors. If an event specified in the contract occurs, such as a delay in payment, and only in this case, the debt is transferred to the security seller against the payment of x million EUR, which corresponds to the capital value. It is up to him to get what he can from the reference entity.

CDS have undergone considerable development and are the support of large and increasingly sophisticated securitization: the combination of CDS into a portfolio; composition of ABS, CDO and CDS.

In 2004, CDS represented a $6 trillion market, which multiplied by ten in four years to reach $60 trillion in 2008. the crisis would be terribly devastating.

In 2008, US insurer AIG held $440 billion worth of CDS and therefore bore the risk of default on the associated loans.

AIG Bankruptcy – Should it Happen could have had a very serious ripple effect. This is why the US government bailed out AIG. However, proper CDS deflation remains a question. And the difficulties of this credit insurance market are added to the financing difficulties that the companies were facing at the time.

This market has shrunk significantly, accounting for $9,316 billion at the end of June 2022, according to the Bank for International Settlements (BIS).

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