23-03-2010, 08:52 PM
Credit default swaps are mentioned only very briefly in ST4. Much more information in ST5, although even ST5 barely scrapes the surface. (Loads of information about CDSs available on the web).
In terms of ST4, the key things to be aware of are:
- a credit default swap pays out if a particular bond defaults
- so a pension scheme could buy a credit default swap that makes reference to a bond issued by the sponsoring employer. Therefore, if the employer defaults on a coupon payment or a final redemption payment then the credit default swap will pay out.
- The company will only default on a bond payment if it is in financial trouble. So by purchasing a credit default swap the pension scheme is obtaining some financial protection in the event that the scheme sponsor gets into financial difficulties.