What should everyone know about default swaps?

What should everyone know about credit default swaps?

A credit default swap (CDS) is a financial contract that works like insurance against a borrower defaulting on a loan or bond. The buyer of a CDS pays regular premiums to the seller, and in return, the seller agrees to compensate the buyer if the borrower fails to meet debt obligations.

In simple terms, it’s a way for investors to transfer credit risk.

Key points to know:

A CDS doesn’t require owning the underlying debt — it can be used purely for speculation.

It played a major role in the 2008 financial crisis because large institutions sold too many CDS contracts without enough reserves to cover potential defaults.

Today, CDS markets are more regulated, but they still influence global credit markets.

Investors use them for hedging (risk protection) or speculating (betting on credit events).

In short: Credit default swaps are powerful financial tools — useful when managed responsibly, but dangerous when misused.