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Understanding Credit Default Swaps

By Satya Srinivasan, IFMR Blog Team

Credit Derivatives are great financial tools that help entities manage their risk in a better, more efficient way. They isolate specific aspects of Credit Risk from an underlying instrument and transfer that risk between two parties, thus helping the parties to the contract manage their exposure to Credit Risk. They are particularly efficient as they isolate specific risk from the asset with which the risk is associated. The most popular type of credit derivative is the Credit Default Swap (CDS). The first Credit Default Swap contract was introduced by JP Morgan in 1997.

The Reserve Bank of India, recently released the Draft Guidelines for introduction of CDS in the Indian markets.

At a recent Spark session, Shruti Viswanathan from IFMR Capital spoke about the essential elements of a CDS contract and highlighted the key features of the RBI Draft Guidelines.

Credit Default Swaps, in their simplest form, are bilateral financial contracts in which the Protection Buyer pays a periodic fee in return for a Contingent Payment by the Protection Seller following a Credit Event.

The following section gives a brief explanation of the various terms and entities involved in a CDS transaction.

Read the rest on the IFMR Blog

Credit Default Swaps cartoon

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