Definition of credit default swap - CDSCredit default swap - CDS Under a credit default swap agreement, a protection buyer pays a periodic fee to a protection seller. The seller agrees to pay the buyer in the event of a default. If the bond is in default, the protection seller either takes delivery of the defaulted bond for the par value (physical settlement) or pays the protection buyer the difference between the par value and recovery value of the bond (cash settlement). Credit default swaps are like an insurance policy, as they can be used by debt owners to hedge against credit loss. However, because there is no requirement to actually hold any asset or suffer a loss, credit default swaps can also be used to speculate on changes in credit spread.
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