What are Credit Default Swaps?
The reason that a credit swap seems like an insurance policy is for two reasons. The regularly scheduled payments are one factor, but most importantly it is the risk of default that is transferred – which seems to be very similar to insurance. However, it is done through parties and the holder of the fixed income trades security to the seller.
Ultimately a credit swap is a way for corporations to manage risk. The process is complicated and not for the novice investor. This complicated system actually made significant contributions to the credit crisis of 2008. The money involved in the credit swaps market is about double the amount in the stock market. Since the purpose of a credit swap is to cover losses on some securities in the event of a default the money flowing around is a factor that fed the fire of the economic crisis from a whole different angle.
The SEC does not regulate the credit swap market, so they have a completely different set of standards by which they have to operate. Both the buyer and the seller can trade the commodities involved in the swap. Because it is not a regulated industry, the swaps can occur without anyone overseeing the trades to ensure the buyer has the resources to cover the losses to cover the possible defaults.