A credit default swap is a particular type of swap designed to transfer the credit exposure of fixed income products between two or more parties. In a credit default swap, the buyer of the swap makes payments to the swap’s seller up until the maturity date of a contract. In return, the seller agrees that, in the event that the debt issuer defaults or experiences another credit event, the seller will pay the buyer the security’s premium as well all interest payments that would have been paid between that time and the security’s maturity date. A credit default swap is, in effect, insurance against non-payment. Tools for analyzing credit default swaps are available in Financial Toolbox™.
In a typical workflow, pricing a new CDS contract
involves first estimating a default probability term structure using
The breakeven, or running, spread is the premium a protection buyer must pay, with no upfront payments involved, to receive protection for credit events.
The current value, or mark-to-market, of an existing CDS contract is the amount of money the contract holder would receive or pay to unwind this contract.
A CDS market quote is given in terms of a standard spread and an upfront payment, or in terms of an equivalent running or breakeven spread, with no upfront payment.
These examples show bootstrapping with inverted CDS market curves, that is, market quotes with higher spreads for short-term CDS contracts.
This example shows how to price first-to-default (FTD) swaps under the homogeneous loss assumption.
A credit default swap (CDS) is a contract that protects against losses resulting from credit defaults.