Credit swap refers to a credit default swap. A credit default swap (CDS) is a contract designed to transfer the credit exposure of fixed income products between parties. The buyer of a CDS pays the seller a series of premium payments in return for protection from investment failure.
This transfers the risk of default is transferred to the seller. The seller makes a profit since s/he receives regular premium payments. However, in case of default, the seller has to pay off the buyer to cover the buyer’s loss.
Credit swaps are currently not regulated, making them prone to anomalous practices. A problematic scenario is when a seller resells the CDS without notifying the buyer first. In this case, the buyer believes that he is still covered or protected by the original seller in case of default or bankruptcy but in fact, is now covered by a completely different entity. If the buyer does need to cash in on his policy, he will end up having a hard time tracking down the entity that is now supposed to be covering him for loss. This happens easily–credit default swaps are sold over the counter and thus can be traded from one party to another very easily.
