Explain what counts as a credit event for CDS and how CDS contracts are settled
The idea
Credit events that trigger a CDS payout are bankruptcy, failure to pay and, in many contracts, restructuring that makes creditors worse off, such as a lower coupon or longer maturity. A determinations committee decides whether an event has occurred. A succession event, such as a merger that moves the debt to a new entity, is different: it may change the reference entity rather than trigger a payout. Settlement is physical, where the buyer delivers obligations and receives the notional, or cash, where the seller pays notional × (1 − recovery). Recovery is usually set by an auction on the cheapest-to-deliver obligation. Do not confuse paying the loss with paying the recovery.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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