Credit Default Swap (CDS)¶
A credit default swap (CDS) is a bilateral over-the-counter derivative contract in which a protection buyer pays periodic premiums to a protection seller in exchange for compensation if a specified credit event occurs on a reference entity. Credit events typically include default, bankruptcy, or failure to pay. The contract references a specific borrower and debt obligation, with notional amounts commonly starting at $5 million.
HOW IT WORKS¶
The buyer pays an annual spread, quoted in basis points of the notional amount, usually settled quarterly in arrears. The spread reflects the market's implied default probability, adjusted for recovery assumptions, liquidity premia, and counterparty risk. Pricing equates the present value of expected premium payments to the present value of expected default losses, where expected loss equals probability of default multiplied by loss given default. If a credit event occurs, the seller pays the buyer the notional amount less the recovery value of the reference obligation, either through physical settlement of the bonds or a cash payment. CDS contracts do not require the buyer to hold the underlying bond; naked positions are legal and common.
IN TAPEBOARD¶
Tapeboard surfaces single-name CDS spreads and index CDS levels—including CDX and iTraxx—alongside cash bond yield spreads so traders can monitor the CDS-bond basis in real time. A negative basis alert flags contracts where CDS protection is cheaper than the equivalent bond credit spread, highlighting potential basis trade opportunities. The CDS detail view shows the implied default probability, the breakeven recovery rate, and quarterly premium cash flows for a given notional and spread, allowing traders to stress-test positions before execution.