Credit Default Contract

DEFINITION of 'Credit Default Contract'

Security with a risk level and pricing based on the risk of credit default by one or more underlying security issuers. Credit default contracts include credit default swaps (CDSs), credit default index contracts, credit default options and credit default basket options. Credit default contracts are also used as part of the mechanism behind many collateralized debt obligations (CDOs); in these cases, the contracts may have unique covenants that exclude company events, such as a debt restructuring as a "credit event".


BREAKING DOWN 'Credit Default Contract'

The main goal of credit default contracts is to establish a price for a given default risk, where it can then be traded to another party who wishes to accept it. Growth of credit default contracts has exploded in recent years, as liquidity has grown along with institutional investor interest. They are a versatile tool for transferring risk away from a lender's balance sheet (such as in CDS) or for pure speculation by hedge funds and other investment vehicles.

The biggest risk in credit default contracts is their extreme sensitivity to individual company and market fluctuations. If fear of default starts to creep into the credit default markets, spreads will rise across the board, making the cost of protection that much more expensive, and slowing down activity in the debt markets as a whole.

RELATED TERMS
  1. Credit Default Swap - CDS

    A particular type of swap designed to transfer the credit exposure ...
  2. Collateralized Debt Obligation ...

    An investment-grade security backed by a pool of bonds, loans ...
  3. Recession

    A significant decline in activity across the economy, lasting ...
  4. Risk

    The chance that an investment's actual return will be different ...
  5. Triggering Event

    1. A tangible or intangible barrier or occurrence that, once ...
  6. Synthetic CDO

    A form of collateralized debt obligation (CDO) that invests in ...
Related Articles
  1. Bonds & Fixed Income

    Credit Default Swaps: An Introduction

    This derivative can help manage portfolio risk, but it isn't a simple vehicle.
  2. Bonds & Fixed Income

    Corporate Bonds: An Introduction To Credit Risk

    Corporate bonds offer higher yields, but it's important to evaluate the extra risk involved before you buy.
  3. Options & Futures

    Hedge Funds Go Retail

    Find out how average investors are breaking into what was once reserved for the ultra rich.
  4. Personal Finance

    The Fuel That Fed The Subprime Meltdown

    Take a look at the factors that caused this market to flare up and burn out.
  5. Options & Futures

    How To Sell Put Options To Benefit In Any Market

    Selling a put option is a prudent way to generate additional portfolio income and gain exposure to desired stocks while limiting your capital investment.
  6. Options & Futures

    How To Buy Oil Options

    Crude oil options are the most widely traded energy derivative in the New York Mercantile Exchange.
  7. Investing Basics

    How You Make Money In Real Estate

    No matter what anyone tells you, the basic ways that money is made through real estate haven’t changed in centuries.
  8. Stock Analysis

    ValueAct Capital: An Activist Investor Analysis

    Read an in-depth review of activist hedge fund ValueAct Capital, which saw nearly all of its 2015 gains eliminated in a matter of weeks during Q3 2015.
  9. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  10. Fundamental Analysis

    HF Performance Report: Did Hedge Funds Earn Their Fee in 2015?

    Find out whether hedge funds, which have come under tremendous pressure to improve their performance, managed to earn their fee in 2015.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  3. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  4. Can hedge funds trade penny stocks?

    Hedge funds can trade penny stocks. In fact, hedge funds can trade in just about any type of security, including medium- ... Read Full Answer >>
  5. Are hedge funds regulated by FINRA?

    Alternative investment vehicles such as hedge funds offer investors a wider range of possibilities due to certain exceptions ... Read Full Answer >>
  6. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
Hot Definitions
  1. Short Selling

    Short selling is the sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is ...
  2. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  3. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  4. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  5. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  6. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center