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    Question

    A contract between two parties in which one party purchases protection from another party against losses from the default of a borrower for a defined period of time is called:

    A Credit debt obligation Correct Answer Incorrect Answer
    B Credit linked note Correct Answer Incorrect Answer
    C Credit default swap Correct Answer Incorrect Answer
    D Credit default obligation Correct Answer Incorrect Answer
    E None of the above Correct Answer Incorrect Answer

    Solution

    A credit default swap (CDS) is a contract between two parties in which one party purchases protection from another party against losses from the default of a borrower for a defined period of time. A CDS is written on the debt of a third party, called the reference entity, whose relevant debt is called the reference obligation, typically a senior unsecured bond. The two parties to the CDS are the credit protection buyer, who is said to be short the reference entity’s credit, and the credit protection seller, who is said to be long the reference entity’s credit. The CDS pays off upon occurrence of a credit event, which includes bankruptcy, failure to pay, and, in some countries, involuntary restructuring.

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