In simplest form Its buying insurance against a default.
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
- CDS going wild (forexlive.com)
- Lehman Brothers: a primer on Credit Default Swaps (creditwritedowns.com)
- The depressed market for Greek default recoveries (ftalphaville.ft.com)
- Greek CDS spreads at record; Italy, Spain stable (marketwatch.com)
- Those Greek credit default swaps? (forexlive.com)
- FSA Said to Review Credit-Default Swaps in Market Abuse Probe (businessweek.com)