North American Loan Credit Default Swap Index - LCDX

DEFINITION of 'North American Loan Credit Default Swap Index - LCDX'

A specialized index of loan-only credit default swaps (CDS) covering 100 individual companies that have unsecured debt trading in the broad secondary markets. The LCDX is traded over the counter and is managed by a consortium of large investment banks, which provide liquidity and assist in pricing the individual credit default swaps.

The index begins with a fixed coupon rate (225 bps); trading moves the price and changes the yield, much like a standard bond. The index rolls every six months. Buyers of the index pay the coupon rate (and purchase the protection against credit events), while sellers receive the coupon and sell the protection. What is being protected is a "credit event" at the company, such as defaulting on a loan or declaring bankruptcy.

If a credit event occurs in one of the underlying companies, the protection is paid out via physical delivery of the debt or through a cash settlement between the two parties. The underlying company is then removed, and a new one is placed in the index to return it to 100 members.

BREAKING DOWN 'North American Loan Credit Default Swap Index - LCDX'

Credit default swaps essentially put a price on the risk of a particular debt issuer's default. Companies with strong credit ratings have low risk premiums, so protection can be purchased for a minimal fee, assessed as a percentage of the notional (dollar) amount of the underlying debt. Companies with low credit ratings cost more to protect against, and the credit default swaps covering them may cost several percentage points of the notional amount.

Minimum purchase amounts for the LCDX run in the millions, so most investors are large institutional firms who invest as either a hedge or a speculative play. The advantage is that one can gain access to a diversified group of companies for much less than purchasing the credit default swaps individually.