why do swap prices decline as credit quality increases
Since the CDS is not tie to a physical asset it can be bought and sold. Speculation on the credit-spread works drives buying and selling of CDS contracts. Without a CDS, a third party profits by identifying, a company with weak financial performance and offers to pay $900k for a $1 million bond from party B and profits $100k, if the company paid its debt. With CDS, party B profits: “Alternatively, one could enter into a credit default swap with the Party B, by selling credit protection and receiving a premium of $100,000. If the company does not default, one would make a profit of $100k without investing anything.” Speculation profits are on the margin. Swap prices decline as credit quality increases and rise when quality worsens. “Someone who believes that a company’s credit quality will change could potentially profit more from investing in swaps than in the underlying bonds.”[Learn More ...]
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