Understanding Credit Default Swaps (CDS)

Very Easy Credit Analysis And Valuation Credit Derivatives

In the world of fixed income securities and credit risk management, credit derivatives are vital financial instruments. They allow investors to transfer credit risk without transferring the underlying asset. A primary type of credit derivative is the credit default swap (CDS), which provides protection against the default of a borrower. Understanding the basic features and functionalities of these instruments is crucial for effective credit analysis.

Given this context, which of the following statements best describes a credit default swap (CDS)?

A CDS is a contract that allows the buyer to receive a predetermined payment in case the borrower defaults.

A CDS allows the seller to purchase bonds from the buyer at face value regardless of the borrower's performance.

A CDS is an equity instrument that pays a dividend to the holder based on the borrower's revenue.

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