Index Credit Default Swap

A credit default swap (CDS) that is linked to a basket of credit derivatives. This swap works primarily as if the swap buyer and seller are entering into several individual credit default swap agreements with trivial modifications. In this sense, this swap is an extension to the single name credit default swap (single-name CDS). Instead of one reference entity, the agreement references several entities. In other words, the swap references all the names (entities) in the index so much so that in the event of default, the credit event is settled based on the name’s weight in the index.

The composition of a credit default index (CDX) changes on a periodical basis (usually every six months). Investors may use swaps on credit indexes to hedge a portfolio of credit default swaps or bonds against the risk of default, at lower costs compared with buying credit default swaps. Index credit default swaps provide, also, a benchmark for bond investors against the default of issuing entities. Trades use these swaps to speculate on changes in credit quality of fixed income securities (bonds).