Credit default swaps: insurance against bankruptcy

Credit default swaps are used to protect against the bankruptcy of a country or company. There is extensive trading by investors in swaps to protect against bankruptcy in Greece, Portugal, Belgium, Ireland, Italy and Spain. The swaps are also used as an investment form. This involves speculation on a country going bankrupt. Swap sellers are often insufficiently aware of the risks. A credit default swap is an agreement used to insure a portfolio of bonds. It is an agreement between two parties. The credit risk is shifted to a third party. Investors have the option to invest in bonds. Investors usually receive a certain interest or profit on these bonds. These bonds can come from companies as well as from individual countries. Investors can then enter into a credit default swap. The party with whom they conclude the credit default swap receives a certain percentage of the profit. In return, they promise to compensate the third party for the loss in the event that there is a loss.

Investing in Credit default swaps

The percentage you pay on the profit from your bonds depends on the chance that a company or country will go bankrupt. You will usually only incur a loss on your bond in that case. In other cases, a company or country will pay out money, or at worst not pay out any money, but you won’t put any money down either. Credit default swaps are also used as an investment form. In that case, swaps are concluded, but without the investor owning bonds of the company or country in question. it is, as it were, betting on the bankruptcy of a country or company. The demand for credit default swaps will increase in the event that a country or company is in danger of going bankrupt. In that case, the swaps can be sold for much more money.

Credit default swaps: insurance against bankruptcy

Trade in credit default swaps has increased rapidly in recent decades. Trading reached a temporary peak in the second half of 2007, when more than 62 trillion dollars, or approximately 40,000 billion euros, worth of swaps were traded. Subsequent trade fell sharply. There are also major risks associated with swaps. This risk is mainly run by the party with whom the swaps are concluded. They usually exclude swaps mainly to make money. These parties, mainly banks and insurance companies, often do not take enough into account that a country or company can actually go bankrupt. Sometimes it is difficult to properly assess the risks and they then incur high costs in the event that a bank actually goes bankrupt. In 2008, for example, few parties saw it coming that several Icelandic banks would go bankrupt. The banks Landsbanki, Glitnir and Kaupthing then went bankrupt and the sellers of the swaps had to pay 7 billion euros in costs.

Buy credit default swaps for Greece, Portugal, Belgium, Ireland, Italy and Spain

Due to the risks associated with swap trading, several governments have also tried to ban swap trading if the underlying bonds are missing. Swap trading is also regularly seen as an indication of whether or not a country or company will go bankrupt. That chance increases when trading in credit default swaps increases. During the Euro crisis, trading in swaps involving Greece, Spain, Portugal, Italy, Ireland and Belgium, among others, increased rapidly. This was because many investors feared that these countries would go bankrupt. The Central Bank of Greece caused a lot of commotion when it concluded Default Credit Swaps with regard to Greece. The Central Bank of Greece therefore speculated on Greece’s bankruptcy.