Potential Benefits of CDSs
Credit default swaps (“CDSs”) can benefit market participants in various ways. CDSs can benefit lenders to CDS reference entities in the credit risk management process. By supplementing loan sales and securitizations with another credit risk management tool, CDSs give lenders flexibility in choosing a preferred credit risk transfer solution, which can free up capital and facilitate additional lending to reference entity borrowers. CDSs can also benefit investors by enabling them to make synthetic investments in the unfunded reference entity’s bonds. Finally, CDS prices can provide useful information to CDS users and other market participants about the expected default risks, recovery rates, potential interconnectedness, and other aspects of underlying reference names. We discuss here these potential benefits of CDSs.
KeywordsCredit default swap CDS Loan sales Loan securitization Hedging Risk transfer Synthetic bond investment Informational role of CDS spreads Price discovery Expected default rates Recovery rates
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