What is a 'Credit Event'

A credit event is any sudden and tangible (negative) change in a borrower's capacity to meet its payment obligations that triggers a settlement under a credit default swap (CDS) contract. CDS contracts are governed by the Master Agreement of the International Swaps and Derivatives Association (ISDA), a trade group representing and promoting the interests of hundreds of market participants "to make the global derivatives markets safer and more efficient."

BREAKING DOWN 'Credit Event'

The three most common credit events, as defined by the ISDA, are bankruptcy filing, payment default and debt restructuring. Three others — obligation default, obligation acceleration and repudiation/moratorium — are infrequent credit events. In the 1980s, the need for more liquid, flexible and sophisticated risk management products for creditors laid the foundation for the eventual emergence of credit default swaps.

A credit default swap is a transaction in which one party, the "protection buyer," pays the other party, the "protection seller," a series of payments over the term of the agreement. The buyer, in essence, is taking out a form of insurance on the possibility that a debtor will experience an event that jeopardizes its ability to meet payment obligations. The purchase of the CDS can be a hedge if the buyer is exposed to the underlying debt of the borrower, but since CDS contracts are traded, a third party could be making a bet that either: a) the chances of a credit event increase, in which case the value of the CDS will rise, or b) a credit event actually occurs, leading to a profitable cash or physical settlement. (Most settlements are in cash.) The seller receiving the series of payments from the buyer would not have to perform settlement of the contract if no credit event arises during the term. It would benefit from all the premium payments from the buyer over the term.

  1. Credit Default Swap - CDS

    A particular type of swap designed to transfer the credit exposure ...
  2. Credit Default Contract

    Credit default contracts are products that shift risks between ...
  3. Credit Derivative

    A credit derivative is a financial asset in the form of a privately ...
  4. Reference Asset

    A reference asset, also known as a reference obligation, is an ...
  5. Asset-Backed Credit Default Swap ...

    An asset-backed credit default swap (ABCDS) protects a buyer's ...
  6. Default Model

    Default model is constructed by financial institutions to determine ...
Related Articles
  1. Trading

    Credit Default Swaps: An Introduction

    This derivative can help manage portfolio risk, but it isn't a simple vehicle.
  2. Investing

    Market Tremors in Credit Default Swaps

    The market for credit default swaps has taken a hit lately.
  3. Personal Finance

    Debt Settlement Arrangements And Your Credit Score

    The debt settlement process is not for everyone and can further damage your credit score. However, it can prevent the debt from being sold to a collection agency, who may only accept payment ...
  4. Trading

    Different Types of Swaps

    Identify and explore the most common types of swap contracts. Swaps are derivative instruments that represent an agreement between two parties to exchange a series of cash flows over a specific ...
  5. Trading

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  6. IPF - Banking

    Money Market Accounts or CDs: Which Investment is Better?

    Find out which short-term savings vehicle, a money market accounts (MMA) or a certificate of deposits (CDs), is a better investment for your needs.
  7. Personal Finance

    Take the Right Steps to Build Excellent Credit

    There are several things you can do to protect and improve your credit score.
  8. Personal Finance

    6 Ways To Build Credit Without A Credit Card

    It's definitely possible – if a bit more complicated – to build a credit history without traditional credit cards. Just follow these steps.
  9. Personal Finance

    Why You Should Improve Your Credit and How to Do It

    With credit playing a big role in many financial decisions, it is important to maintain good credit.
  10. Personal Finance

    The Importance Of Your Credit Rating

    A great starting point for learning what a credit score is, how it is calculated and why it is so important.
  1. Do certificates of deposit help build credit?

    Learn about certificates of deposit, including if these securities are a useful tool to help build your credit score. Read Answer >>
  2. What is the difference between derivatives and swaps?

    Swaps comprise just one type of the broader asset class called derivatives. Read Answer >>
  3. In what types of financial situations would credit spread risk be applied instead ...

    Find out when credit risk is realized as spread risk and when it is realized as default risk, and learn why market participants ... Read Answer >>
Trading Center