Credit Default Swaps (CDS)

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    In News

    • Recently, the regulator Securities and Exchange Board of India (Sebi) allowed alternative investment funds (AIFs) to participate in the Credit Default Swaps (CDS) market.

    New Norms

    • For Buying:
      • Under the new norm, Category-I and Category-II AIFs can buy CDS on underlying investment in debt securities only for the purpose of hedging.
      • Category-III AIFs can purchase CDS for hedging or otherwise, within permissible leverage.
    • For Selling:
      • Category-II and Category-III AIFs may sell CDS by earmarking unencumbered government bonds or Treasury bills equal to the amount of the CDS exposure. 
    • Significance:
      • The new norms will allow business entities to hedge risks associated with the bonds market.
      • These norms will facilitate deepening of the domestic corporate bond segment. 

    Credit Default Swaps (CDS)

    • About:
      • A CDS is a type of derivative that transfers the credit exposure of fixed income products.
      • CDS is a specific kind of counterparty agreement which allows the transfer of third party credit risk from one party to another.
      • CDS can be used for speculation, hedging, or as a form of arbitrage.
      • Credit default swaps played a role in both the 2008 Great Recession and the 2010 European Sovereign Debt Crisis.
    • Process:
      • In a credit default swap contract, the buyer pays an ongoing premium similar to the payments on an insurance policy. 
      • In exchange, the seller agrees to pay the security’s value and interest payments if a default occurs.

    Source: ET