Single-Name CDS: Understanding Single-Name Credit Default Swaps

Introduction

Single-Name Credit Default Swaps (CDS) are financial derivative contracts that serve as a form of insurance against the default of a specific entity, typically a corporation or sovereign state. A single-name CDS involves a buyer who makes periodic payments to a seller in exchange for compensation if the reference entity defaults on its obligations.

Types

Single-Name CDS can be categorized based on:

• Reference Entity Type: Corporate CDS, Sovereign CDS
• Credit Event Specifications: Bankruptcy, Failure to Pay, Restructuring
• Maturity: Typically ranging from 1 to 10 years

Detailed Explanation

A single-name CDS operates as follows:

Structure

• Parties Involved:

  • Protection Buyer: Pays regular premiums.
  • Protection Seller: Receives premiums, compensates in default event.

• Premium Payments: Made by the protection buyer, generally quarterly.

• Credit Event: Defined circumstances under which a payout occurs, such as default or restructuring.

• Settlement:

  • Physical Settlement: The protection seller buys the defaulted asset from the buyer.
  • Cash Settlement: The protection seller pays the buyer the difference between the par value and the market value of the defaulted asset.

Mathematical Models

CDS pricing involves complex models. The following is a simplified version:

Importance

• Risk Management: Helps investors hedge against credit risk.
• Price Discovery: Provides insights into the creditworthiness of entities.
• Arbitrage Opportunities: Traders exploit price differences between CDS and underlying bonds.

Related Terms

• Multi-Name CDS: A CDS that covers a basket of entities or a credit index.
• Credit Event: An event triggering a payout, such as default.
• Recovery Rate: The percentage of the asset’s value recovered in case of default.

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