Which of the following best describes a credit default swap?
A)it is protected against default
B)it has a higher rate to compensate for the possibility of one party defaulting
C)it carries a higher credit rating than most other swaps
D)it off if another party external to the swap defaults
E)none of the above

Question

Quizplus · Accepted Answer

A credit default swap (CDS) is a financial derivative that allows an investor to "swap" or offset their credit risk with that of another investor. It is essentially an insurance policy on the default risk of a particular credit instrument, such as a bond or loan. When a CDS is purchased, the buyer of the swap makes payments to the seller over the life of the contract. In return, the seller agrees to pay off the debt if the original issuer defaults.
The correct answer to the question is:
D) it pays off if another party external to the swap defaults.
This is because a credit default swap is a contract that pays the buyer of the swap in the event that a third party, such as a bond issuer, defaults on their obligations. The buyer of the CDS receives protection against default, while the seller of the CDS collects periodic payments and assumes the risk of default. If the third party does not default, the seller profits by keeping the payments, but if a default occurs, the seller must compensate the buyer for the loss.

Which of the Following Best Describes a Credit Default Swap