Credit default swaps are the most common form of derivative in the fixed-income market. The swaps are complex investment vehicles that can be used to protect a bond buyer from the risk of default.
If a bond issuer fails to keep to the terms of its debt agreement, the owner of the swap can collect face value of the bond.
Bond investors use credit default swaps to reduce risk. Speculators invest in the swaps as a way to place bets on the likelihood of a bond default.
When the price of credit default swap falls, it's an indicator that investor confidence in a bond issuer is rising.
A CDS can be used as an alternative to bond insurance, which is a popular tool in the muni bond market.