Jeff Block from Thomson Financial's Corporate Advisory Services group discusses Credit Default Swaps. Transcript: The growth and impact of a popular derivative security known as credit default swaps have captured financial headlines this year. Many people have heard of them but are at a loss as to what they are, why they are relevant, and their impact on financial markets. My name is Jeff Block with Thomson Financials Strategic Research group to provide basic insight to these opaque securities. First, a credit default swap, or CDS, is an over-the-counter financial contract between two parties that is used to trade the credit risk of a specific company. In its most simple form, the buyer of a CDS is buying protection from the risk that a company might not be able meet its interest and principal payments on its outstanding bonds. Now if the credit risk of a company increases for some fundamental reason, the price of protection increases as well. Think of the concept of buying auto insurance -- if you are a careless driver prone to accidents, you can expect your annual premium to increase. Well, the pricing of credit default swaps is similar. An interesting thing about credit default swaps is that the issuing company is actually not directly involved in the trades. The major participants are usually banks, portfolio managers and traders. The other side of the credit default swap trade, known as the counter party, is the seller and he assumes the risk that a company may not be able to make its payment obligations to bondholders. Like any insurance company, the seller of the credit default swap will receive a fee, or premium, for taking this risk. The greater the risk of the company defaulting on payments, the greater premium. If the company experiences a credit even such as becoming insolvent, the CDS buyer will be compensated. Let me emphasize that the CDS market is not just for hedgers looking for protection. Traders will use these contracts to speculate the future credit of a company. If you buy a CDS contract, you are essentially short the credit. The only way you make money is if the premium moves higher and that will happen if credit concerns of the company increase. Conversely, if you sell a CDS contract, you are long the credit. The trader is not concerned with the risk that the issuing company will experience a credit event and the compensation is the premium paid by the CDS buyer. Let me add that the trading behavior of CDS may indicate a leak in material information that has yet to be picked up on the radar of the equity and option markets. It is prudent for corporations to keep an eye on credit default swaps on their issues prior to material announcements. It also indicates traders' views on the health of the company credit. The credit default swap market has increased in popularity over the past several years, exponentially I might add- it has an estimated notional value near $46 trillion. That is almost five times the size of the US National Debt. One thing to note is the CDS market is unregulated and the industry must police itself, something that has drawn the ire of U.S lawmakers, specifically Senator Charles Schumer. There are also indices on credit default swaps that are terrific barometers for the health of the credit markets called the CDX indices. The CDX indices appear have an inverse correlation with the M&A market. The higher these indices move indicates uneasiness in the credit markets which have an inverse affect on M&A activity. The higher the indices go, the less deal activity may occur because of an unfavorable environment for financing. That's all for now - Thank you for listening. For more information on this topic please visit the corporate services center.