Main Features of CDS
The main features of CDS are as follows:
1. CDS is a non-standardized private contract between the buyer and seller. Therefore, it is covered in the category of Forward Contracts.
2. They are normally not traded on any exchange and hence remains free from the regulations of Governing Body.
3. The International Swap and Derivative Association (ISAD) publishes the guidelines and general rules used normally to carry out CDS contracts.
4. CDS can be purchased from third party to protect itself from default of borrowers.
5. Similarly, an individual investor who is buying bonds from a company can purchase CDS to protect his investment from insolvency of that company. Thus, this increases the level of confidence of investor in Bonds purchased.
6. The cost or premium of CDS has a positive relationship with risk attached with loans. Therefore, higher the risk attached to Bonds or loans, higher will be premium or cost of CDS.
7. If an investor buys a CDS without being exposed to credit risk of the underlying bond issuer, it is called “naked CDS”.
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