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Five Shocking Facts About Contingent Credit Default Swap | contingent credit default swap

A contingent credit default swap is a modified version of a standard CDS which requires two triggers, usually a negative credit event and a negative reading on a benchmark or index. The credit event is something that takes place between the time of the contract formation and delivery. The negative reading is on the other end of the contract and happens after delivery. It is usually seen in mortgage debt transactions, where the debt has to be paid before a certain date.

Most contingent credit default swaps are mortgage-based. The loans are usually created through a securitization process and structured as second mortgages. The structure creates a lien on the underlying property. When a payment event takes place, the lien is converted into a security and the payer (the person who purchased the loan) is given a right to redeem it by paying the balance due. The borrower (who now owns the security) can then sell it back to the buyer (or the person who financed the loan) at a later date for a profit.

The typical counterparty in a contingent credit default swap is the mortgage company. In some cases, however, it can be the seller of the note, who makes the sale in order to fulfill a debt obligation. In most cases, however, it is the bank, and they do not make any profit from this type of swap. They would rather just have the money in their custody instead of making a sale and possibly having the asset repossessed by the counterparty.

The transferability of the underlying assets used in a contingent credit default swap is not immediately apparent. Since the transferability of the underlying assets in this type of swap is not clear, this also means that there is no clear-cut definition of “counterparty” as one individual or entity. It is possible, however, for one party to be the counterparty and another party be the underlying asset owner. That is, a homeowner could be the counterparty to a bank's CCJ-style mortgage while that homeowner's lender is the asset owner and borrower to the mortgage.

Unlike bank credit default swaps, mortgage homeowners' CCJ-style mortgages do not automatically convert them from one lender to another once a borrower defaults on a loan. Instead, the counterparty is the home owner who sells the home to eliminate his or her outstanding liability. This process does not change the ownership structure of the underlying assets in any way. The same holds true for other types of CCJ-style credit default swaps. Both lenders and borrowers continue to own the underlying properties even when one or another has defaulted.

There are two major types of contingent credit default swaps. The first is an “automatic” swap where the value of one or more mortgages is guaranteed by the assets of one or more underlying lender participants. The second is a “manual” swap in which the actual cash value of the underlying loan is used as the value of the collateral securing the swap. In this way, CCJs and other similar financial transactions create a hybrid, or contingent, credit event.

Of course, any given credit event is either a contingent or unconditional swap. A contingent credit default swap is one in which the credit event – a default of an underlying debt obligation – creates a risk-premium that is greater than the cash value of the underlying asset that is used as collateral in the swap transaction. On the other hand, a unconditional credit default swap is one in which the credit event – a default of an underlying asset that is the source of debt obligation – does not create a risk-premium because the specific event itself (a default of the loan itself) neither creates nor guarantees a financial loss for the participant. Both types of swaps are used primarily as hedging instruments against negative events such as interest rate changes and other factors.

Most importantly, it should be noted that any time a borrower takes on a secured credit event, they become subject to the risks associated with their underlying collateral. This means that although many CDSs are highly leveraged and can provide large premium rates when paired with a preferred stock or other collateral, they can also come back to haunt the investor should the borrower defaults on the debt obligation. If the value of your collateral drops, you may not have enough capital to satisfy the full amount of your interest or principal. As such, CDSs should be used with extreme caution and only in cases where you have considered every possible outcome and have determined that a default is likely or unavoidable.


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Credit default swap – Wikipedia – contingent credit default swap | contingent credit default swap


Introduction to Credit Derivatives and Credit Default Swaps – contingent credit default swap | contingent credit default swap


The chain of contingent credit default swaps (CCDS) replicating – contingent credit default swap | contingent credit default swap

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