Finance
What is A credit default swap?
A credit default swap (CDS) is a financial contract that works like insurance against a borrower failing to repay a debt. One party pays regular fees, and in return the other promises to cover the loss if the debt defaults.
See it, don’t just read it.
Watch a 2-minute lesson with voice + animation that explains a credit default swap.
Key things to understand
- 1It's essentially insurance on a loan or bond defaulting.
- 2The buyer pays periodic premiums; the seller pays out if the borrower defaults.
- 3It lets investors hedge risk — or speculate on a borrower failing.
- 4You can buy one without owning the underlying debt, which adds risk.
- 5Their misuse amplified the 2008 financial crisis.
Frequently asked questions
- How is a credit default swap like insurance?
- You pay regular premiums and get a payout if a specific bad event — a borrower defaulting on its debt — happens. A key difference is that it's tradable and was lightly regulated.
- Why were credit default swaps blamed for the 2008 crisis?
- Huge volumes were written on risky mortgage debt, often by parties who couldn't cover the payouts. When defaults cascaded, the losses spread through the financial system.
- Can anyone buy a credit default swap?
- In practice they're traded between large financial institutions, not everyday investors — they're complex instruments far removed from ordinary banking.