The market at a glance
Credit derivatives isolate one question — will the borrower pay? — and make it tradable on its own. Born in the 1990s, the market peaked pre-2008 above $60 trillion notional, then consolidated post-reform to a cleaner core: roughly $9–10 trillion of CDS notional, dominated by the index products, largely centrally cleared, plus a structured layer (CLOs, ~$1.3tn) that finances the leveraged-loan world.
Users split by need: banks shedding concentrated loan exposure (and lately, whole-portfolio capital relief via SRT deals), credit funds expressing long/short views a cash bond can't (shorting credit means buying protection), and macro traders using indices as the fastest recession-risk dial available.
The credit triangle — this market's E=mc²
One approximation organises everything here: spread ≈ default intensity × loss severity.
$$ s \;\approx\; \lambda \,(1 - R) $$
A 200bp spread with 40% recovery implies a ~3.3% annual default intensity. Every quote you see — single-name CDS, index level, CLO tranche margin — is a statement about \(\lambda\) and \(R\). The calculator below inverts it live.
How the products fit together
The single-name CDS is the atom: insurance on one borrower. CDS indices (CDX, iTraxx) bundle 100+ names into macro credit instruments with options and tranches on top. Credit-linked notes fund the same risk into a bond wrapper for investors who can't trade derivatives. CLOs apply the tranching idea to portfolios of leveraged loans — an actively managed securitisation that has become the buyout industry's banker.
Concepts to master
- Spread duration vs. jump-to-default — two different risks: mark-to-market pain from spread widening, and the binary loss when default actually hits. Books are managed on both.
- The basis — CDS and bonds price the same credit; their gap (the CDS-bond basis) trades on funding, deliverability and documentation, and blows out precisely in crises.
- Correlation — tranches turn the portfolio loss distribution into products: equity tranches fear many small defaults, seniors fear the correlated catastrophe. Correlation is the price of "together".
- Credit events are legal facts — determinations committees, auction protocols and restructuring clauses decide payouts; documentation literacy is alpha here.
Why this market matters beyond itself
Credit spreads lead. The high-yield market and CDS indices typically reprice weeks before equities accept bad news — "credit leads equity" is one of the most durable cross-asset regularities. Watching iTraxx Crossover is watching the economy's overdraft warning light.