Chapter 2. Credit derivative instruments and applications
Credit Derivatives Products
The credit default swap is the basic building block for most ‘exotic’ credit derivatives and hence, for the sake of completeness, this chapter sets out a short description before exploring more exotic products. A credit default swap (CDS) is used to transfer the credit risk of a reference entity (corporate or sovereign) from one party to another. In a standard CDS contract, one party purchases credit protection from the other party, to cover the loss of the face value of an asset following a credit event. A credit event is a legally defined event that typically includes bankruptcy, failure to pay and restructuring.