Credit Default Swaps:
Securities and Exchange Board of India (SEBI) announced that mutual funds can now sell credit default swaps (CDS) citing the need to aid liquidity growth in corporate bond market, according to its latest circular.
- The move follows RBI’s directive in 2022 to provide revised regulatory framework for debt derivatives. So far, only buying CDS’s were permitted. Allowing both purchase and sale of the instrument will improve flexibility for MFs.
- Credit Default Swap (CDS) is a financial derivative that allows an investor to transfer the credit risk of a debt instrument, such as a bond, to another party.
- A CDS is essentially a contract between two parties: the buyer and the seller. The buyer of the CDS makes periodic payments to the seller in exchange for protection against the default of a debt instrument, such as a bond or loan.
- The buyer pays regular premiums to the seller, similar to an insurance policy.
- If the underlying debt instrument defaults or a specified credit event occurs (e.g., bankruptcy, failure to pay), the seller compensates the buyer.
- The compensation typically includes the face value of the debt instrument and any unpaid interest.
