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If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction. In addition to the basic, single-name swaps, there are basket default swaps (BDSs), index CDSs, funded CDSs (also called credit-linked notes), as well as loan-only credit default swaps (LCDS).
The payment received is often substantially less than the face value of the loan. In addition to corporations and governments, the reference entity can include a special purpose vehicle issuing asset-backed securities.
That is, the seller of the CDS insures the buyer against some reference asset defaulting.
The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, may expect to receive a payoff if the asset defaults.
In this way, a CDS is similar to credit insurance, although CDS are not subject to regulations governing traditional insurance.If the reference entity (i.e., Risky Corp) defaults, one of two kinds of settlement can occur: The "spread" of a CDS is the annual amount the protection buyer must pay the protection seller over the length of the contract, expressed as a percentage of the notional amount.For example, if the CDS spread of Risky Corp is 50 basis points, or 0.5% (1 basis point = 0.01%), then an investor buying million worth of protection from AAA-Bank must pay the bank ,000.Payments are usually made on a quarterly basis, in arrears.These payments continue until either the CDS contract expires or Risky Corp defaults.