CREDIT DEFAULT SWAPS Amanda Williams

Used to shift credit exposure to a credit protection seller. Primary purpose is to hedge the credit exposure to a particular issuer. What is a Credit Default Swap?

Credit Default Swaps  The protection buyer pays a fee to the protection seller  In return for the right to receive a payment conditional upon the occurrence of a credit event  Should a credit event occur, the protection seller must make a payment  Can be settled in cash or physically

Doesn’t have to be a bond. Example

History:  Started in 1994 by Blythe Masters  JPMorgan make a loan to Exxon  Transfer risk and not tie up cash reserves  European Bank of Reconstruction and Development  Now in charge of default risk  Credit derivative contract

Role in economic crisis:  Made on subprime mortgages  Banks playing both sides  No regulations

Mortgage Collapse  Trillions of dollars in CDS  Higher than average default rates  Couldn’t pay CDS  Bankruptcies & bailouts  AIG  Lehman Brothers

Questions?