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What Is a Credit Default Swap Index?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 23 November 2016
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    2003-2016
    Conjecture Corporation
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A credit default swap index is a type of credit security that makes it possible to create and manage a portfolio of credit default swaps in a manner that is somewhat easier than attempting to manage individual credit default swaps. This particular investment approach effectively creates a credit derivative that the investor can then utilize as a unified basket of securities, making it somewhat easier to hedge on the collective amount of volatility that is involved with the various holdings that are part of the index. The end result is that a credit default swap can be very helpful in minimizing risk to the investor and also aid in projecting any shifts or changes that could occur with the credit quality of any of the swaps included in the index.

One of the chief benefits of a credit default swap index is that the arrangement helps to insulate the investor from some of the risk that is involved with the collection of swaps held. This approach means that it is possible to take on different types of credit swaps with varying degrees of volatility, knowing that any possible losses with one or two of the swaps will be offset by the returns realized on the swaps carrying a lower opportunity for default. This type of credit derivative arrangement makes the credit default swap index ideal for anyone who wants to invest in bonds and other types of similar assets, but wants to hedge against potential losses.

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Another advantage to a credit default swap index is that the cost of managing the assets included in the index can be lower. Since the assets can be managed as a single entity, this means lower broker or dealer fees, while still allowing the investor the option to trade the swap when and as desired. When combined with the ability to manage default risk to better advantage, utilizing the index can be ideal for investors who prefer to buy and hold, while still reserving the ability to trade when and if projections indicate that doing so would be in the best interests of the investor.

Like any investment strategy, a credit default swap index cannot eliminate all the risk involved. The exact level of risk will vary, depending on the volatility that is associated with each of the swaps or bond that are currently part of the index. Investors will need to assess the holdings, using information that is obtained through the marketplace, determine if a particular credit default swap index fits well into their financial plans and goals, then choose the index that seems to be the best option.

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