Credit Default Swap: Definition, Structure, Use, and Potential Misuse

Gracia S. Ugut

Apr 2024 · Penerbit NEM

About this eBook

Credit default swaps and credit derivatives in general are one of the many specialized derivatives that are used for the purpose of hedging, speculation and arbitrage. The primary purpose of a credit derivative or the need behind the creation of such a product is to serve as a credit risk transfer mechanism. Credit risk is one of the four broadly classified types of risks (others being operational risk, market risk and liquidity risk) is the possibility of a loss resulting from a borrower’s failure to repay a loan or meet contractual obligations. Credit Default Swaps and Credit Derivatives gained popularity in the pre and during Global Financial Crisis in 2008. It has earned a bad reputation since then as it is perceived as one of the most dangerous financial derivatives. The decline in trading volume of emerging market sovereign CDS in the years since the 2008 global financial crisis, along with the steady rise in volume of emerging-market-bond ETFs, might have contributed to this increase in the relative efficiency of bond-price discovery.

Credit-Default Swaps (CDS) were generally a better source of price discovery than spreads computed from bond prices. Credit-Default Swaps (CDS) tended to be a better measure of value compared to spreads computed from bonds, which may have been traded infrequently. However, since the COVID-19 crisis, the cash bond market appears to have made strong inroads as the better source for investors to compare relative value and risk.

About the author

Gracia S. Ugut, has extensive experience in managing Higher Education institutions and international partnerships, with a strong academic background as a Full Professor of Finance and as business developer in academic settings. From 2001-2013, she was the Dean-Executive Education at the Asian Institute of Management, the oldest business school in Asia, set up by Harvard Business School in Manila, in 1968. During her stint at the Institute, she had an opportunity to do a series of research on corporate governance in ASEAN banks, sponsored by CV Starr and AIG, and research on the development of local debt/bond market in ASEAN and presented her paper on ASEAN Regional Currency Arrangement in the ASEAN Forums in the region as a response to the Asian Financial Crisis.

Before joining the institute, she had been working as a banker in Europe and Southeast Asia. She is also a certified trainer from Consultative Group to Assist the Poorest (CGAP-World Bank) for microfinance in Asia. She was serving as a Senior Advisor to the Board of CARD MRI, the largest Microfinance Institution in the Philippines, from 2005-2012 and Head of Panel of Jury of Arabia CSR Forum Award in Dubai, UAE, from 2008-2016.

Since returning to Jakarta in 2014, she has been the Dean of Universitas Pelita Harapan (UPH) Business School. She served as Council Member of Global Education Council at the World Economic Forum (WEF) between 2015-2017 and Ketua Komisi Tetap (Komtap) Pendidikan Vokasi in Indonesia Chamber of Commerce KADIN Pusat from 2015-2020. Trained as a financial economist, her research interest is in capital markets, derivatives and fixed income market and strategies. She also continuously explores the ideas at the intersection between modern finance and capital market and sustainability/ESG issues.

Gracia Ugut earned her Ph.D. in Financial Economics from Vienna University of Economics (Austria) in 1995. She is married with two adult children.