Credit default swap index

A credit default swap index is a credit derivative used to hedge credit risk or to take a position on a basket of credit entities. Unlike a credit default swap, which is an over the counter credit derivative, a credit default swap index is a completely standardised credit security and may therefore be more liquid and trade at a smaller bid-offer spread. This means that it can be cheaper to hedge a portfolio of credit default swaps or bonds with a CDS index than it would be to buy many single name CDS to achieve a similar effect. Credit-default swap indexes are benchmarks for protecting investors owning bonds against default, and traders use them to speculate on changes in credit quality.

There are currently two main families of corporate CDS indices: CDX and iTraxx. CDX indices contain North American and Emerging Market companies and are administered by CDS Index Company (CDSIndexCo) and marketed by Markit Group Limited, and iTraxx indices contain companies from the rest of the world and are managed by the International Index Company (IIC), also owned by Markit.

A new series of CDS indices is issued every six months by Markit. Running up to the announcement of each series a group of investment banks is polled to determine the credit entities that will form the constituents of the new issue. This process is intended to ensure that the index does not become "cluttered" with instruments that no longer exist, or which trade extremely illiquidly. On the day of issue a fixed coupon is decided for the whole index based on the credit spread of the entities in the index. This coupon is set usually to 100bps (1% p.a.) for predominantly Investment Grade indices and 500bps for predominantly speculative grade indices to follow the convention of Standard North American Corporates (SNAC). Prior to SNAC (i.e. CDX.NA.IG Series 3 through 11) the coupons were set to approximate the average weighted spread of the names in that index. Once this has been decided the index constituents and the fixed coupon are published, and the indices can be actively traded.

Most indices will be quoted at a theoretical traded spread in basis points. This represents the fraction of the protected notional that would be paid yearly. The standardisation of indices means that instead of paying the theoretical spread, the fixed (or running) spread (as defined in the index documentation) is paid. It also means that coupon payments are not at fixed intervals starting from the trade date - payment dates are fixed on the 20th of March, June, September, and December. This means that the first coupon period may be a different length to the others. To offset the difference between traded spread and running spread, and the accrual from the first coupon period, an upfront fee is paid.

...
Wikipedia