Pro lesson, preview locked
Unlock the full video and walkthrough with FinanceFlow Pro.
5:00CDS: Insurance on a House You Don’t Own
A credit default swap pays out when a borrower defaults, but unlike home insurance you can buy it on a "house" you never owned. In 2008 AIG sold this protection by the hundreds of billions, never hedged it, and needed a $182bn rescue.
A credit default swap (CDS) is a bilateral contract that transfers the default risk of a borrower (the reference entity) from a protection buyer to a protection seller. The buyer pays a periodic premium; if a credit event occurs, the seller makes the buyer whole. It walks and talks like insurance, but with one decisive difference: you do not have to own the underlying bond to buy protection on it. A position with no underlying exposure is a naked CDS, a pure bet that the borrower will fail.
Unlock the full lesson with Pro
The complete walkthrough, rail map and quiz for CDS: Insurance on a House You Don’t Own, plus every Pro lesson in the library.