What Is Credit Default Swap Index (CDX)?
The credit default swap index (CDX)—formerly the Dow Jones CDX—is a financial instrument made up of credit securities that have been issued by North American or emerging markets companies.
The credit default swap index (CDX) is itself a tradable security—a credit market derivative. But the CDX index also functions as a shell, or container, as it is made up of a collection of other credit derivatives—credit default swaps (CDS). Currently, the CDX contains 125 issuers and is broken down by different types of credits: investment grade, high yield, high volatility, crossover, and emerging markets. Every six months, the underlying securities of the CDX are examined and, if appropriate, replaced with new securities. This helps to ensure that the index remains current and is not cluttered with investments that no longer exist, or which are very illiquid.
Understanding Credit Default Swap Index (CDX)
Credit default swap indexes (CDX) track and measure total returns for the various segments of the bond market cited above so that the overall return can be benchmarked against funds that invest in similar products. Investors can use the CDX index’s tracking to monitor their own portfolios against this benchmark and adjust their holdings accordingly. The CDX helps to hedge risk by protecting bond investors against default, and traders use CDX indexes to speculate about potential changes in issuers’ credit quality.
Why Invest in a CDX Index?
The CDX index is completely standardized and exchange-traded, unlike single CDSs, which trade over the counter. As such, the CDX index has a high level of liquidity and transparency. CDX indexes also may trade at smaller spreads than CDSs. Thus, investors may hedge a portfolio of default swaps or bonds with a CDX more cheaply than if they were to buy many single CDSs to achieve a similar effect. Finally, the CDX is a well-managed tool that is subjected to intense industry scrutiny twice a year. The existence of tools such as CDX indexes makes it easier for both institutional and individual investors to trade in complicated investment products that they otherwise might not want to own separately.
The CDX index came into being in 2001, a complicated time in financial markets—perhaps to help make investing in complex, high-risk (potentially high-yielding) financial products a little less complicated and a little bit safer.