CDS = Credit default Swaps. In simplest form Its buying insurance against a default. For example:
I’m a banker, gave car-loans to dude, but I’m afraid he might not pay back the full money.
So I’ll goto some other Bank X who sells Credit default Swaps (CDS).
I’ve to pay regular premium Bank X,
but if someday that dudes default on his car-payment, Bank X will pay me the money.
In a CDS transaction, the protection buyer does not suffer a loss when reference entity defaults.
These CDS bonds, once issues, can be sold and bought like any other bond or security.
i.e. Bank X sells my CDS to Bank Y. So now Bank Y gets my premium but in case of default by that Dude, Bank Y is supposed to pay me.
In Jan 2013, RBI updated the CDS guidelines. As per the revised guidelines-now, CDS will be permitted also on
- securities with original maturity up to one year like Commercial Papers, Certificates of Deposit and non-convertible debentures
- listed corporate bonds
- unlisted but rated corporate bonds
Why CDS important for economy?
- CDS, as a risk management product, offers the participants the opportunity to hive off credit risk.
- such products would increase investors’ confidence in corporate bonds (because they can transfer risk)
- thus it would be beneficial to the development of the corporate bond market.
(CDS also means combined defense services exam, conducted by UPSC)