CDS : Credit default swaps

In simplest form Its buying insurance against a default.

Example

I’m a banker, gave car-loans to dude, but I’m afraid he might not pay back the full money. So I’ll goto some other Bank X who sells Credit default Swaps (CDS).

I’ve to pay regular premium Bank X, but if someday that dudes default on his car-payment, Bank X will pay me the money.

RBI is currently drafting rules for starting a CDS market in India.

These CDS bonds, once issued, can be sold and bought like any other bond or security but only thing is that they are not regulated.

i.e. Bank X sells my CDS to Bank Y. So now Bank Y gets my premium but in case of default by that Dude, Bank Y is supposed to pay me.

# As described by Mrunal

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2 thoughts on “CDS : Credit default swaps”

  1. What action will be taken against the Guy, who couldn’t pay the amount..?

    Analogy of CDS is easy, but how it happens in Market..?

  2. @Umesh From the above example you must have understood that it is used for risk-management. As of now nothing can be done if the guy doesn’t make the payment and defaults. That is what happened in USA and led to the global recession.

    I think RBI was planning to make rules regarding the same. Don’t know whether they have made the rules or not.

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