Credit Default Swaps
Betting against a company's bonds without owning them
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The Basic Idea
- A CDS is a contract between two parties: the protection buyer and the protection seller.
- The buyer pays a periodic premium (the "spread"). In return, if the reference company defaults, the seller pays out.
- It's insurance—but tradeable, and you don't need to own the thing you're insuring.
CDS Protection Buyer: Two Outcomes
Binary outcome: if the company survives, you lose all premium paid. If it defaults, you receive a large payout. Asymmetric risk/reward.
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