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Credit derivatives terminology

By Vinod Kothari  

   

Basket Default swap: A credit default swap referenced to a basket or a bunch of reference obligations, usually all equally-weighted, where losses will be transferred to the protection seller based on the terms of the swap. The terms of the swap could be first-to-default or second-to-default, or for that matter, n-th-to-default. If the terms of the swap are first to default, the losses on the first obligation to default in the basket will be transferred to the protection seller, and thereafter, the swap will be terminated. Likewise, in case of the second-to-default swap, the losses on the first default will not be transferred to the protection seller, but those on the second default will be transferred, and thereafter, the swap is closed. Basket swaps are essentially correlation products for a basket of uncorrelated portfolio, the probability of more than one default in a basket is negligible, and so, the protection buyer buying protection on first-to-default in the basket has virtually covered himself against the entire basket.

 

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