Mechanics of a Credit Default Swap (CDS)

Buyer: Buys CDS. Is seeking to reduce exposure or to hedge. Receives protection against the potential default of a low-credit-quality bond. Profits when the bond's credit deteriorates. Pays a periodic fee. If there's a default, gives the defaulted bond to the seller. Seller: Sells CDS. Is seeking to enhance exposure. Guarantees the credit-worthiness of the bond. Profits when the bond remains stable or its credit fundamentals improve. Receives a periodic fee. If there’s a default, gives agreed-upon amount to buyer. For illustrative purposes only.

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