What is the difference between Gordon Brown and Ronald McDonald? The answer is that it costs more to insure against default by Mr Brown than it does against default by Ronald McDonald. I will explain....
A credit default swap (CDS) is a contract between two counterparties, the buyer and the seller. The "seller" offers to provide insurance against default by a bond issuer. In return for this insurance, the "buyer" pays a premium to the "seller". The size of the premium, or spread, will be determined by the creditworthiness of the borrower. In other words, a CDS is just an insurance policy. As you may have expected, last year the premiums/spreads for CDSs rose dramatically. Six months ago, the CDS premium for 5 year UK government bonds was lower than for both Japanese bonds and 5 year...
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