A credit default swap:
A) transfers the credit risk in a fixed income instrument from one counterparty to another.
B) is not considered a credit derivative.
C) provides the buyer with periodic payments.
D) can only be traded if the seller owns the underlying instrument.
E) all of the above.

Question

Quizplus · Accepted Answer

A credit default swap transfers the credit risk from one party to another. The buyer of the CDS pays periodic payments (premiums) to the seller in exchange for a promise that the seller will pay the face value of the bond in case of default. The CDS is one type of credit derivative that is used to mitigate the risk of default in fixed income instruments. Option B is incorrect because a CDS is considered a credit derivative. Option C is incorrect because the buyer of the CDS pays the premiums to the seller, not the other way around. Option D is incorrect because the seller of a CDS is not required to own the underlying asset.

A Credit Default Swap