credit default swap CDS--CREDIT DEFAULT SWAP is one of the credit derivatives. The contract is traded by two legal persons, one is called the buyer (the protected party in case of credit default) and the other is called the seller (to protect the buyer from losses in case of credit default). When the buyer borrows money from a third party (debtor) under mortgage, but he is worried that the debtor will not repay the loan in default, he can buy a contract/insurance about the debtor from the credit default swap contract provider. Usually, this contract requires regular contributions until the debtor's repayment is completed, otherwise the contract will be invalid. If the debtor defaults and fails to repay (or other circumstances specified in the contract make people believe that the debtor is unable or has no intention to repay on time), the buyer can claim compensation from the seller with the collateral in exchange for the due debt. What the seller earns is the contract gold/insurance premium if the debtor repays the loan according to the contract.

some credit default swap contracts need not use collateral to claim compensation from the seller (the amount of compensation is directly proportional to the insurance premium), and only need the debtor to go bankrupt (or other circumstances specified in the contract). The function of these contracts is not limited to risk transfer (hedging), but speculative. For example, the buyer can bet on a company that is about to go bankrupt by contract, and he has never lent money to the company.

Better explanation:

Credit Default Swap, a credit default swap, was initiated by JPMorgan Chase in 1995 as a financial derivative product derived from credit card loans, which can be regarded as a kind of default insurance for financial assets. The creditor sells the debt risk through this contract, and the contract price is the premium. The party who buys credit default insurance is called the buyer, and the party who takes risks is called the seller. Both parties agree that if there is no default in financial assets, the buyer will pay the "insurance premium" to the seller regularly, and once there is default, the seller will bear the loss of the buyer's assets. CDS is the most widely traded OTC credit derivative in the world.

the emergence of credit default swaps meets this market demand. As a highly standardized contract, credit default swap enables institutions holding financial assets to find guarantors who are willing to bear the default risk for these assets. Among them, the party who buys credit default insurance is called the buyer and the party who bears the risk is called the seller. Both parties agree that if there is no default in financial assets, the buyer will pay the "insurance premium" to the seller regularly, and once there is default, the seller will bear the loss of the buyer's assets. There are generally two ways to bear the loss. One is "physical delivery". Once a default event occurs, the insurance seller promises to buy the buyer's default financial assets in full at face value. The second way is "cash delivery". When a default occurs, the insurance seller makes up the buyer's asset loss in cash. Credit default events are events recognized by both parties in advance, including: the debtor of financial assets goes bankrupt and pays off, the debtor fails to pay interest on time, and the creditor requests to recall the debt principal and demand early repayment and debt restructuring caused by the debtor's violation. Generally speaking, insurance is mainly bought by banks or other financial institutions that hold a large number of financial assets, while credit default insurance is sold by insurance companies, hedge funds, commercial banks and investment banks. Both contract holders are free to transfer this insurance contract.

On the surface, credit default swap, a credit derivative, satisfies the concerns of the holders of financial assets about the risk of default, and also provides a new source of profit for insurance companies or hedge funds willing and able to bear such risks. In fact, once the credit default swap came out, it aroused enthusiastic pursuit in the international financial market, and its scale soared from 1 trillion US dollars in 2 to 62 trillion US dollars in March 28. Among them, this figure only includes the data reported by commercial banks to the Federal Reserve, but does not cover the data of investment banks and hedge funds. According to statistics, only hedge funds have issued 31% credit default swap contracts.

according to relevant research, the credit default swap market is the most likely to have problems. In May 28, Buffett said: "According to my definition, the American economy has fallen into recession." One area of concern is the $6 trillion credit default swap market. According to the research results, Lei Yao, a researcher in the international financial market of the People's Bank of China, pointed out that "according to the current development trend of the subprime mortgage crisis, the CDS market with a valuation of about 62 trillion US dollars has become a' barrier lake' in the current financial market". "With the deterioration of the quality of credit assets, the decline of the real economy, the credit crunch and the continued turmoil in the financial market in major European and American countries, the risk factors in the credit derivatives market will inevitably rise. Among them, traders' credit risk has become the primary weak link that may lead to systemic risk, which needs to be paid close attention to, and the adverse consequences such as bond price decline and further credit crunch that may be caused by the outbreak of systemic risk need to be prevented. In addition, institutional investors represented by hedge funds may have liquidity risks, and the operational risks caused by the failure of pricing models in complex links also need to be given some attention. " He believes that the credit crunch risk caused by the CDS market problem may be more rapid than the "Fannie and Freddie incident", which will exert continuous pressure on China's exports through shrinking consumption.

It should be noted that the figure of $62 trillion only includes the data reported by commercial banks to the Federal Reserve, but does not include the data of investment banks and hedge funds. According to statistics, only hedge funds have issued 31% credit default swap contracts; On the other hand, credit default swaps are completely over-the-counter transactions without any government supervision.

The largest part of the p>CDS market is corporate bonds (including ABS), accounting for 8%, while MBS accounts for 2%. In the state of economic recession, the default rate of corporate bonds will rapidly climb from the current 4.87% to more than 1%. Based on the loss recovery rate of 5%, CDS will cause direct losses of $1 trillion in the coming months. However, some financial institutions in China have purchased such derivatives, which is worthy of vigilance.