Single Name CDS
A Single Name Credit Default Swap (CDS) is a type of financial derivative that is used to hedge against the risk of default by a specific borrower, such as a corporation or a sovereign nation. The CDS is essentially a contract between two parties, the buyer and the seller, where the buyer pays a periodic fee to the seller in exchange for protection against the default of the borrower.
The buyer of a Single Name CDS is typically a creditor of the borrower or an investor who is exposed to the borrower’s credit risk. By purchasing the CDS, the buyer is essentially buying insurance against the risk of default. In the event that the borrower defaults, the seller of the CDS is obligated to compensate the buyer for the losses incurred as a result of the default.
The premium for a Single Name CDS is based on the perceived creditworthiness of the borrower. The higher the perceived risk of default, the higher the premium that the buyer of the CDS will have to pay. The premium is usually expressed as a percentage of the notional value of the CDS. The notional value is the amount of the underlying debt that the CDS is referencing, but the buyer of the CDS does not need to own the underlying debt.
Single Name CDS can be used in a variety of ways, including as a means of hedging against credit risk or as a speculative investment. For example, a creditor of a borrower can purchase a CDS as a way to hedge against the risk of default, thereby reducing their exposure to credit risk. Alternatively, an investor can purchase a CDS as a way to bet on the creditworthiness of a borrower or to speculate on the price movements of the CDS.
One advantage of Single Name CDS is that they provide a way for investors to diversify their credit risk exposure. By purchasing CDS on a variety of borrowers, investors can spread their credit risk across a portfolio of borrowers, reducing their exposure to any single borrower. However, Single Name CDS can also be a source of systemic risk, as a large number of CDS contracts can lead to a concentration of risk in a small number of counterparties.
Overall, Single Name CDS can be a useful tool for managing credit risk, but they also come with their own set of risks and challenges. As with any financial instrument, it is important to understand the mechanics of Single Name CDS and the risks involved before investing.
There are two main types of Single Name CDS:
- Standard Single Name CDS: This type of Single Name CDS is based on a single reference entity, such as a corporation or a sovereign nation. The buyer of the CDS pays a periodic fee to the seller in exchange for protection against the risk of default by the reference entity. If the reference entity defaults, the seller of the CDS is obligated to compensate the buyer for the loss incurred. Standard Single Name CDS can be used to hedge against the credit risk of a specific reference entity, or as a speculative investment.
- Bespoke Single Name CDS: This type of Single Name CDS is customized to meet the specific needs of the buyer and seller, and is typically based on a reference entity that is not included in a standard index. Bespoke Single Name CDS can be tailored to meet specific investment objectives or risk management needs, and can include a mix of investment grade and high yield entities, as well as entities from different sectors or regions. Bespoke Single Name CDS can be a useful tool for managing credit risk in a customized way, but they also come with their own set of risks and challenges, such as the difficulty of valuing a custom reference entity.