Thread by @thatrpb

Likely going to hear quite a bit about Credit Default Swaps (CDS) this week so wanted to dive into it to get a better understanding as someone not in finance. Sharing here for those who may find this 🧵

Credit Default Swaps (CDS) act like insurance for loans, protecting investors or financial institutions from a borrower's potential default. The CDS buyer pays a fee to the CDS seller, who agrees to cover losses if the borrower can't repay their debt.

Companies issue debt securities (e.g., bonds) to raise funds. Investors buy these securities, lending money to the company and becoming creditors. Creditors may buy CDS to protect themselves against the risk of default on the company's debt obligations.

Companies that lend money to commercial clients can also buy CDS to cover the risk of default on loans issued to their clients. This helps manage credit risk in their lending activities.

CDS can be standardized or bespoke. An example: "SCHW CDS USD SR 5Y D14 Corp" is a 5-year standardized CDS on Charles Schwab's senior debt, denominated in USD. The contract is offered by external parties, not the company itself.

CDS can cover the full amount of debt or just a portion, allowing investors to balance risk exposure and costs. The fees paid depend on the credit risk and coverage amount.

CDS contracts trade in an over-the-counter (OTC) market, separate from the underlying debt securities. This market helps participants manage credit risk and provides insight into a company's creditworthiness.

What we're seeing at the moment, or where some of the alarm is being drawn to, is rapidly rising costs of these CDS contracts for some large, well known banks, including the example above of Charles Schwab.

A rapidly rising price of a company's CDS signals that the market perceives increased risk of default. Higher CDS prices can indicate concerns about a company's financial health, industry trends, or economic conditions.

Higher CDS prices may affect a company's borrowing costs, as investors demand higher yields to compensate for the increased risk. This can also impact the company's reputation and overall market sentiment.

So while some politicians are stating that all is fine, that there is nothing to worry about, these are signals coming from the financial markets that indicate the sentiment isn't shared based on the information and forecasts the same markets have.