A swap agreement that gives the holder the right to sell a contractual obligation (bond, loan) for its face value in the event the issuer defaults. This way, the credit exposure of fixed income instruments is transferred from one party to another. In other words, credit default swaps provide insurance against default (credit event) by a particular corporate or sovereign entity. The protection buyer makes periodic payments (known as CDS spread) to the protection seller at a preset fixed rate per year. The payments continue until the contract expires or a credit event occurs, whichever comes first. The protection buyer will have the right, if a credit event takes place, to deliver the debt instrument (the reference bond) to the protection seller and receive, in return, its face value.

The credit default swap can be viewed as a put option written on the value of the underlying reference debt.

This synthetic financial instrument was invented in Europe in the early 1990s.