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iTraxx® is a range of credit default swap index products. It covers most major markets except for North America, which is mainly covered by a different set of products under the CDX name. The products are based on underlying credit default swaps, which are effectively an insurance contract covering non-payment of loans.
The general principle of a credit default swap is that one party pays premiums to the other. The second party then pays out an agreed fixed amount if a stated credit deal goes into default. This deal could, for example, be a bond or loan.
The most common use of a credit default swap is by lenders. This involves the organization that makes the loan taking out a credit default swap on the loan and receiving a payment if the borrower defaults. In effect the lender insurers against the risk of non-payment, but credit default swaps are not usually subject to the same regulation as insurance contracts. It's also possible to take out a credit default swap without having any involvement in the loan. This is known as a naked credit default swap and is effectively a gamble that the borrower won't repay the loan.
A credit default swap index such those offered by iTraxx® is a financial product based on credit default swaps. In effect, it is a collection of multiple credit default swaps brought together as one product, paying out to the holder depending on the number of defaults. The difference is that the holder can buy or sell the product on the open market like any other security.
There are two main reasons investors use iTraxx® products. Some will use them as a form of hedging. One example of this would be a company that has a lot of exposure to credit risk, through making many loans, taking out an iTraxx product so that it will get some money back if defaults in general are higher than it expects. The seconds reason is simply as an investment in which investors make or lose money depending on how well they can predict both the likelihood of general defaults and their reading of the market for the products.
iTraxx® offers three main index products ranging from one based on the most risky credit default swaps to one based on the most traded credit default swaps. It also offers a variety of index products based on credit default swaps from specific industry sectors. New index products are created every six months, updated in line with the criteria used for selecting the credit default swaps for each particular product.
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