Credit Derivatives

Credit derivatives transfer the risk that a borrower defaults. Here is how credit default swaps work, how they spread risk before 2008 and what happened to AIG.

Insurance on a loan

A credit default swap works like insurance on a bond. The buyer pays a regular premium; if the borrower defaults, the seller pays the loss. Banks and investors use them to hedge loans or bonds, and speculators use them to bet on a company’s credit getting worse without owning the bonds.

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