Credit Default Swap (CDS)

Credit default swap are a type of swap that transfers credit risk  of fixed income securities(usually bonds) between parties. It is similar to an insurance policy on bonds. The buyer of a credit swap receives credit protection and pays a premium to the seller every year, whereas the seller of the swap guarantees the credit worthiness of the product.

CDS are believed to reduce risk by spreading it out, though some believe that CDS actually intensify risk due to the unlimited amount of CDS contracts that can be written on a finite amount of bonds.