Question : A credit default swap (CDS) is a financial instrument used for:
Option 1: Hedging foreign currency risk
Option 2: Trading commodities futures
Option 3: Insuring against the default of a bond issuer
Option 4: Investing in real estate properties
Correct Answer: Insuring against the default of a bond issuer
Solution : The correct answer is (c) Insuring against the default of a bond issuer.
A credit default swap (CDS) is a financial instrument used to hedge or insure against the default of a bond issuer. It is a derivative contract between two parties, typically a protection buyer and a protection seller. Credit default swaps are primarily used by investors and financial institutions to manage credit risk associated with investments in bonds or other debt instruments. They provide a way to transfer the risk of default from the holder of the bond to the protection seller.
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