NEW YORK — Institutional investors are recognizing the importance of protecting fixed-income bets, and the money that can be made off that protection.
General Motors Corp., General Electric Co. and Verizon Communications Inc. are among the pension plans that either have or are considering writing or buying single-name or asset-backed credit default swaps to beef up returns and provide downside protection and lower volatility in their fixed-income portfolios.
Additionally, recent credit-rating downgrades in the auto manufacturing sector, which affected both GM and Ford Motor Co., have prompted heavier use of single-name credit default swaps.
Credit default swaps allow an investor, through a counterparty, to either buy or sell protection against default on a portfolio of debt obligations, such as high-yield bonds or asset-backed securities, or a single debt obligation, such as a high-risk loan or bond. Investors can also buy baskets of credit default swaps through the Dow Jones' North American Investment Grade and High Yield Indexes.
Buyers of such protection pay a periodic premium, usually quarterly, to another party for the life of the protection agreement. In return, the seller of the protection agrees to make a specified payment to the buyer if a specified default occurs.
If the default does not occur, the seller earns a premium on its own portfolio of assets, much as the seller of a put option earns a premium.