Credit default swap

A type of derivative contract in which two parties bet on the risk that some credit instrument will go into default.  Abbreviated as CDS.  The buyer of a CDS agrees to make periodic payments to the seller.  The seller agrees to pay a lump sum to the buyer if the underlying credit instrument enters default. 

If the buyer is actually exposed to the underlying credit instrument, a CDS contract functions much like insurance.  If the buyer is not exposed to the underlying credit instrument, a CDS contract looks more like a mere bet against someone's ability to pay debts.

 

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