Naked Credit Default Swap Friday, October 4, 4:06 PM ET
Referencing our definition of credit default swaps, one of the two parties holds a loan and effectively wants to insure it against default. The second party provides that insurance, for a price.
When the word "Naked" is placed in front of "credit default swap" that describes a scenario where the first party doesn't actually hold the loan, but seeks the insurance on it anyway.
The result is a form of speculation that the company who issued the loan in question might default or the risk of default might rise. In a scenario where default appears to be more likely, the value of an insurance policy against default will rise, creating gains for the speculator.
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