Investments, tenth edition

B: Premiums on Spanish Sovereign Debt CDS Contracts

250

500

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900

0

Jan 08

May 08

Premium (bp/year)

Sep 08

Jan 09

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Jan 12

May 12

50

100

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0

Jan 08

May 08

Premium (bp/year)

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Jan 09

A: Premiums on German Sovereign Debt CDS Contracts

May 09

Sep 09

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May 10

Sep 10

Jan 11

May 11

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Jan 12

May 12

 Figure 14.12 

Pricing of 5-year credit default swaps 

    Source:  Bloomberg, August 1, 2012,  http://www.bloomberg.com/quote/CDBR1U5:IND/chart . 

   

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 We say approximately because there are some differences between highly rated bonds and bonds synthetically 

enhanced with credit default swaps. For example, the term of the swap may not match the maturity of the bond. 

Tax treatment of coupon payments versus swap payments may differ, as may the liquidity of the bonds. Finally, 

some CDSs may entail one-time up-front payments as well as annual premiums.  

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Final PDF to printer

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other eurozone countries worsened. As its perceived credit risk increased, so did the cost 

of insuring its debt.  

 Panel B of  Figure  14.12  shows the premiums on 5-year CDS contracts on Spanish 

government debt. Spain’s economy was far shakier than Germany’s, and its CDS prices 

reflected this fact. By the summer of 2012, its 5-year CDS premiums were around 600 

basis points, about eight times the price to insure German debt. 

 While CDSs were conceived as a form of bond insurance, it wasn’t long before inves-

tors realized that they could be used to speculate on the financial health of particular issu-

ers. As  Figure  14.12  makes clear, someone in early 2011 wishing to bet against Spain 

might have purchased CDS contracts on its sovereign debt and would have profited as 

CDS prices spiked over the next 18 months. The nearby box discusses the role of credit 

default swaps in the financial crisis of 2008–2009.