Speculations on Credit Default Swap Insurance

• A credit default swap index contains many credit default swap contracts, making it more convenient for investing purposes
• Good credit risk management strategies are important to prevent defaults
• Credit default swap (CDS) are receiving a lot of blame for the failure of the global financial markets

Credit default swap (CDS) and credit risk management methods were not widely talked about or well known to many individuals and investors until recently, when the economic and financial crisis and downturn started. Credit default swap insurance can be a good idea. However, in the current financial market speculation has caused this good deal to bring the entire global economy down and is responsible for destabilizing it. Credit default swap contracts are not specifically insurances in the traditional sense, but instead are used to hedge against possible credit defaults. If you believe that AIG Insurance is going to fall and default, good credit risk management would advise that you take out a credit default swap contract. In exchange for a specific amount each month or year, you can receive a contract that makes a third party, such as an insurance company, responsible for this amount if the company does default.
Speculation in the credit default swap market occurs because there are no rules or regulations overseeing this market, and anyone can be party to a contract. If you are paying a premium for this swap contract, and then turn around and sell the same amount of protection to someone else for a larger premium amount each month or year, the difference between what you pay and what you receive is pure profit for you until the default occurs. If a default occurs, you still have your swap contract, so you receive the payout which you pass along to your CDS holder. This means that you can get a swap contract simply because you believe a company will default, even if you have no interest at all in the company. This led to many hedge funds, large and small, to invest in these contracts in the hopes that the default occurred. Many of the companies and institutions which were collecting a premium on credit default swaps were caught facing devastating and catastrophic losses when both the housing and derivatives markets took a nosedive. Due to no regulation or oversight, a lot of the companies and funds did not have the reserve capital necessary to meet their contractual obligations and ended up going under. This is what started the spiraling economic fall of the financial markets around the world.

A credit default swap index is a way that you can invest in a larger number of credit default swaps without having to own each one individually, making them more convenient. In the current market, credit default swap are not very commonly created, and only the most secure of these swaps are even actively traded at times. The credit default swap market and speculation has come to a standstill, as most investors are using good risk management to avoid even more losses. Because large numbers of companies are failing, even big names like Bear Stearns and Lehman Brothers that have been around a long time and were considered stable, very few if any businesses or investors are willing to cover a bet that the bond, stock, or municipality will not default in the future. Wall Street right now is filled with uncertainty and high volatility, and most credit default swaps are not being created or widely traded. This is really interesting because for six years, starting in the year 2001, this market doubled every single year.

Speculations on credit default swap insurance is not what caused the collapse of the financial system. It was rather the companies and banks selling the CDS contracts that did not keep enough cash reserves on hand to cover these contracts if defaults did occur. There has been a lot of talk in Washington about regulating credit default swaps, and the current economic crisis has caused this subject to become popular. This uncertainty about whether regulation will happen and what the regulation will be has also caused these swap contracts to become unpopular at the moment.

The information supplied in this article is not to be considered as medical advice and is for educational purposes only.