Credit derivatives are an exciting innovation in financial markets. They have the potential
to allow companies to trade and manage credit risks in much the same way as market
risks. The most popular credit derivative is a credit default swap (CDS). This contract
provides insurance against a default by a particular company or sovereign entity. The
company is known as the reference entity and a default by the company is known as a
credit event. The buyer of the insurance makes periodic payments to the seller and in
return obtains the right to sell a bond issued by the reference entity for its face value if a
credit event occurs.