Understanding Credit Default Swaps

Very Easy Credit Analysis And Valuation Credit Derivatives

In the context of fixed income securities, credit derivatives are financial instruments used to manage credit risk. They allow one party to transfer the credit risk of a particular asset to another party. One of the most common types of credit derivatives is a credit default swap (CDS). A CDS functions like an insurance policy against the default of a borrower.

Which of the following statements best describes what a credit default swap (CDS) entails?

A CDS is a contract that provides insurance against the default of a borrower, where the buyer pays periodic premiums to the seller.

A CDS is a loan agreement in which the lender agrees to forgive a portion of the debt if the borrower meets certain conditions.

A CDS is a derivative that allows investors to speculate on the interest rate movements of a bond.

Hint

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