credit default swap: meaning, definition, pronunciation and examples
C1/C2Formal/Technical
Quick answer
What does “credit default swap” mean?
A financial derivative contract in which one party (the buyer) makes periodic payments to another party (the seller) in exchange for a promise of compensation if a third party (the reference entity) defaults on a loan or experiences another credit event.
Audio
Pronunciation
Definition
Meaning and Definition
A financial derivative contract in which one party (the buyer) makes periodic payments to another party (the seller) in exchange for a promise of compensation if a third party (the reference entity) defaults on a loan or experiences another credit event.
Often abbreviated as 'CDS'. It functions as a form of insurance against credit risk, but can also be used for speculative purposes. It is a bilateral, over-the-counter (OTC) agreement that transfers the credit exposure of fixed income products between parties.
Dialectal Variation
British vs American Usage
Differences
No significant lexical or conceptual differences. The term is identical in both dialects and is used within the same globalised financial lexicon.
Connotations
Neutral/Technical in both varieties. Since the 2008 financial crisis, it may carry negative connotations of financial complexity and systemic risk in general discourse, but remains a neutral term of art within finance.
Frequency
Equally low-frequency in both dialects, confined almost exclusively to specialist financial, economic, and business journalism contexts.
Grammar
How to Use “credit default swap” in a Sentence
[Institution/Investor] bought a credit default swap on [Entity/Bond] from [Counterparty]The [bank/fund] used a credit default swap to hedge its exposure to [risk].Vocabulary
Collocations
Examples
Examples of “credit default swap” in a Sentence
verb
British English
- The bank decided to hedge its position by buying credit default swaps.
- Several funds were actively trading CDS throughout the quarter.
American English
- The firm hedged by purchasing credit default swaps.
- Investors often use CDS to speculate on a company's creditworthiness.
adverb
British English
- This is purely a credit-default-swap-related issue.
- The position was hedged credit-default-swap-wise.
American English
- The exposure was managed via a credit-default-swap strategy.
- They analysed it from a credit-default-swap perspective.
adjective
British English
- The CDS market showed signs of strain.
- Their credit-default-swap portfolio was highly complex.
American English
- The CDS spread widened dramatically.
- They faced a major credit-default-swap payout.
Usage
Meaning in Context
Business
The hedge fund purchased credit default swaps as protection against its corporate bond portfolio.
Academic
The study analysed the pricing efficiency of the credit default swap market during periods of volatility.
Everyday
The news explained how complicated financial deals called credit default swaps contributed to the banking crisis.
Technical
The five-year senior CDS on the sovereign was trading at 150 basis points, indicating elevated perceived risk.
Vocabulary
Synonyms of “credit default swap”
Strong
Neutral
Weak
Vocabulary
Antonyms of “credit default swap”
Watch out
Common Mistakes When Using “credit default swap”
- Using it as a verb (e.g., 'They credit default swapped the bond' is incorrect).
- Treating it as an uncountable noun (e.g., 'They traded in credit default swap' is incorrect; it is countable: 'They traded in credit default swaps').
- Confusing the 'buyer' (who is buying protection) and 'seller' (who is selling protection/assuming risk).
FAQ
Frequently Asked Questions
No. While it functions similarly, a CDS is a private bilateral contract (a derivative) without the same regulatory safeguards as insurance. The buyer does not need to own the underlying asset (a 'naked' CDS), which is not typical for insurance.
Banks, hedge funds, insurance companies, and other institutional investors use them to manage credit risk exposure or to speculate on changes in creditworthiness.
The seller (or 'writer') receives periodic payments from the buyer and, in return, promises to pay the buyer if a specified credit event (like a default) occurs. The seller is taking on risk.
They were criticised for creating hidden, interconnected chains of risk (counterparty risk), where the failure of one major institution could trigger widespread defaults, and for enabling excessive speculation on failure.
A financial derivative contract in which one party (the buyer) makes periodic payments to another party (the seller) in exchange for a promise of compensation if a third party (the reference entity) defaults on a loan or experiences another credit event.
Credit default swap is usually formal/technical in register.
Credit default swap: in British English it is pronounced /ˈkrɛdɪt dɪˌfɔːlt swɒp/, and in American English it is pronounced /ˈkrɛdɪt dɪˌfɔlt swɑp/. Tap the audio buttons above to hear it.
Phrases
Idioms & Phrases
- “naked CDS (a CDS bought without owning the underlying debt)”
- “CDS is a ticking time bomb (journalistic metaphor)”
Learning
Memory Aids
Mnemonic
Think: CREDIT (a loan) + DEFAULT (failure to pay) + SWAP (an exchange). It's a swap where you exchange payments for a promise to cover a loan default.
Conceptual Metaphor
INSURANCE POLICY (though legally distinct). Commonly framed as 'buying protection' or 'selling risk'.
Practice
Quiz
What is the primary function of a credit default swap (CDS)?